Stock indices: What are they?

Stock market indices refer to statistical measures that exhibit the changes in trends in the stock market. Similar stocks are chosen from a group of securities -- already listed on the stock exchange – and then clubbed together in order to create an index.

The parameters for stock selection can range across market capitalization, type of industry and size of the companies. It is the value of the underlying stocks that makes up the value of the index. It implies that should value of individual securities go up, the index would rise as well.

Notable stock market indices in India

Some of the significant indices in India are:

• Benchmark indices, including BSE Sensex and NSE Nifty
• Broad-based indices, including BSE 100 and Nifty 50
• Market capitalization-based indices, including BSE Small cap, BSE Mid cap
• Sector-based indices, including CNX IT, Nifty FMCG

Importance of stock index

·        Helps stock-picking

Thousands of stocks are listed on the stock exchange. Without a benchmark, it will be difficult to differentiate between stocks and invest in the right one. This is where stock market indices help to classify stocks based on the size of companies, sectors, type of industry, and the likes.

·        Serves as a proxy

Equity investments entail a considerable degree of risk. However, probing into every stock is an impractical solution to mitigating volatility. This is where indices plug investors’ knowledge gaps, considering they exhibit trends of the overall stock market (or a few sectors). In India, the BSE Sensex and NSE Nifty are the benchmark indices, considering they mirror stock market performance.

·        Lays down parameters for comparison

You should know whether your investment in a stock would be worth the money before you make it a part of your portfolio. Comparing the stock with its index can give you a fair idea of how it is performing. For instance, if the stock generates higher returns as compared to the index, it is deemed to have outperformed the index; and vice versa.

·        Reflects sentiments of investors

Besides other factors, gauging investor sentiments assumes significance when you participate in equity markets. Should you want to invest in a particular stock, you must know the dynamics behind the rise or fall in the stock price. This is where stock market indices help you put a finger on investor sentiments.