What is meant by stock market index?

The stock market index measures the performance of a group of stocks. It is used to track the overall performance of the stock exchange or, at times, the overall stock market. 

Common examples of stock market indexes include the Nifty, which tracks the National Stock Exchange (NSE) and the Sensex, which tracks the Bombay Stock Exchange (BSE). 

Similarly, in the US, the ‘S&P 500 index tracks the performance of the top 500 publicly traded companies in the U.S., and the Dow Jones Industrial Average tracks the performance of 30 large publicly traded companies in the U.S. 

When you look at an index, a value pops up. And this value keeps fluctuating throughout the market hours. So, the question is – how is the value of an index determined? 

The value of an index is determined by the prices of the stocks it tracks, with each stock having a weighting based on its market capitalisation. The logic goes – the higher the market cap, the more weightage it will have on the index. The value of the index will rise or fall as the prices of the stocks it tracks change.

Here’s a quick analogy to make things more straightforward – 

An index in the stock market can be considered a “basket” of stocks. Just like a basket of fruits represents a collection of different types of fruits, an index represents a collection of other stocks. 

Imagine a basket of 10 strawberries and 5 mangoes. You can use the basket to track the overall performance of the fruits. If the price of strawberries goes up, the total value of the basket will go up. Similarly, if mangoes go down, the full value of the basket will go down. 

In other words, you are using the basket of fruits as a benchmark to track the performance of the fruits. Similarly, stock market indexes serve as a benchmark for the market’s overall performance or a specific stock exchange present in the market. 

Why do we have indexes?

As an investor, why do we need indexes? Benchmarking is an apparent reason. So, here are some compelling reasons why indexes are a respected member of the hood – 

• Benchmarking

Indexes serve as a benchmark for the overall performance of a market or a specific sector of the market. Indexes are used to compare the performance of individual stocks or portfolios to the broader market.

Otherwise, how tedious would it be to track the daily fluctuations in the market, the impact of each stock on the market, etc.? Things become simple when figures and trackers enter the picture, aye? 

• Portfolio Diversification

Indexes can be used as a way to diversify investments. And diversification is advice that each investor swears by or, at least, tries to follow. 

In fact, by investing in a broad-based index, you can gain exposure to various stocks and sectors. This is much better than restricting yourself to a few companies or industries. 

• Research and Analysis

A lesser-known fact is that indexes are used as a tool to study trends and patterns in the market and to identify investment opportunities. 

E.g., the impact of the Russia-Ukraine conflict on India’s stock market can be easily tracked by following the performance of indexes every day. This has been done before, and reports and articles have been published. 

• Investment Vehicles

Indexes can be used as the basis for exchange-traded funds (ETFs) and index funds, allowing investors like you to gain exposure to the market or specific market sectors with a single investment. 

Note: ETFs and index funds are a basket of stocks (or other securities) that track a particular index, like any individual stock. 

• Measure Of The Economy

Unsurprisingly, indexes also serve as a measure of the economy. How? By tracking the performance of the companies considered to be representative of the economy. 

For E.g. the performance of Tata industries on the stock market can help you get a fair idea of how the Indian economy is faring.

What are the types of indices?

In India, two indexes dominate the stock market. As an investor, you must be aware of both by now. Indexes exist in a variety of types. Here are the three broad types of indexes – 

What Is A Broad Index?

Broad stock market indexes track various stocks across different sectors and industries. These indexes are designed to provide a broad representation of the overall performance of a market or market sector. Some examples of broad stock market indexes include:

• Nifty 50 Index – Part of the NSE, this index tracks 13 sectors of the Indian economy and tracks 50 stocks in the overall market. 
• Nifty 100 Index – A diversified index, it represents the stocks of 100 distinct companies in India with a large market capitalisation. It also tracks the combined behaviour and performance of two indexes – NIFTY 50 and NIFTY Next 50. 

• S&P BSE Sensex Index – Also known as Sensex, it is the predominant index of BSE and tracks the performance of companies listed under this exchange. 

• India Vix index – A lesser-known index, it is part of NSE and measures how much volatility the market expects in the near term. Thus, it is also known as Nifty’s Volatility Index. 

What Are Sectoral Indices?

Simply put, the sectoral stock market index tracks the performance of stocks in a specific market sector. These indexes allow investors and analysts to track the performance of a particular industry or group of industries. Some examples of sectoral stock market indexes include:

• NIFTY Auto Index – As indicated in the name, this index tracks and reflects the behaviour of the automobile sector of the Indian economy. A BSE counterpart of this index is the S&P BSE Auto index. 

• NIFTY Bank Index covers liquid banking stocks with large market capitalisation. The benchmark captures the overall market performance in the Indian banking segment. The BSE counterpart is called S&P BSE Bankex. 

• NIFTY Oil and Gas Index – No points for guessing that this index tracks the market performance of companies involved in the oil, gas and petroleum business. The BSE counterpart is called S&P BSE Oil & Gas. 

Such sectoral indexes also exist for capital goods, consumer durables, FMCG products, etc. 

What Is Thematic Index?

Often, investors need clarification while distinguishing between sectoral and theme-based indices. So, let’s try to understand the latter while mitigating confusion. 

Theme-based indexes are stock market indices that track the performance of companies in a specific industry or sector, such as technology or healthcare. These indices can provide investors with a way to gain exposure to a particular theme or trend in the market, such as the growth of renewable energy or the adoption of electric vehicles.

Here, while the automobile is a ‘sector’, ‘adoption of electric vehicles’ is a particular theme. And a diverse range of companies that contribute to this theme is included in this theme-based index. Some common examples of theme-based indexes include – 

• NIFTY Housing Index – ThiAsname suggests this index aims to track the performance of company stocks that broadly represent the housing theme. A counterpart of this exists in BSE called the S&P BSE Housing index. 

• NIFTY India Consumption Index – This index represents a portfolio of stocks that are part of the domestic consumption theme, like pharmaceuticals, consumer non-durables, hotels, media and entertainment, etc. A direct counterpart of this does not exist in the BSE. Instead, an S&P BSE Consumer Discretionary index that represents stocks belonging to the consumer discretionary goods & services sector exists. 

• NIFTY India Manufacturing Index – This index represents stocks from the Nifty 100, Nifty Midcap 150 and Nifty Smallcap 60 index, contributing to the manufacturing theme. The BSE counterpart is called S&P BSE India Manufacturing Index.

What Is An Index Fund?

As the name suggests, an index fund is a type of mutual fund or exchange-traded fund (ETF) that aims to replicate the performance of a specific market index, such as the S&P BSE Sensex or NIFTY 100, etc. 

The fund’s portfolio is constructed based on its benchmarked index and typically includes all or specific samples of the securities in the index. To put things into perspective, let’s take the example of a popular index fund in India, i.e., Tata Nifty 50 Index Fund. 

As the name suggests, the Tata Nifty 50 Index Fund was started by an arm of Tata Industries, i.e., Tata Mutual Fund. It tracks and aims to replicate the Nifty 50 index while minimising the losses. Of course, it does not include all stocks benchmarked by the Nifty 50 index, but only a few. 

Index funds are often considered a low-cost and passively managed investment option, as there is no requirement for a fund manager to select and trade individual securities actively.

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