A Primer on Stock Indices

The words Sensex and Nifty are the most commonly heard stock market terms. Every investor encounters these terminologies frequently while taking heed of stock market discussions among friends and relatives. Sensex and Nifty are two popular indices that indicate the overall performance of Indian stock markets. Armaan Madhani furnishes a detailed understanding of the nuances of stock indices, its types, significance and application

- Armaan Madhani

A stock index is a statistical measure that exhibits the changes in the trends of the stock market in general. Indices are used to represent the performance of the broader security market, or a particular segment of it. An index is created by clubbing together stocks based on a pre-defined criterion which depends on the characteristics of a specific index. The value of the index is calculated using the values of the underlying stocks that make up the index. Consequently, any changes in the prices of these stocks will impact the overall value of the index. Therefore, let’s say that if a majority of the stocks in the index were to witness an increase in their prices, the value of the index will go up as a whole and vice-versa.

Index Construction and Management Indices are constructed by using various methods. A good index is a trade-off between diversification and liquidity. The process starts by identifying stocks to include in the index. These are chosen based on certain qualitative and quantitative parameters, laid down by the index construction managers or entity. However, index providing entities must make several critical decisions such as what is the target market the index is intended to measure, which stocks from the target market should be included, how often should the index be rebalanced and when should the selection and weighting of securities be re-examined.