What Is Index In Stock Market In India

An Index is a benchmark that reflects the overall situation of the stock market, industry, sector, etc.

In the context of the Indian Stock Market, the commonly discussed stock market indices are Sensex and Nifty50. The Sensex has the top 30 companies in the country in terms of market capitalization while the Nifty50 has 50 top companies based on the same criteria.

Types of Stock Market Index

Stock market indices can be of various types. The categorization can be done based on factors like sector, theme, market capitalization, etc. The different types of stock market indices are listed in the table below.

Type of Stock Market Index	Description	Example
Benchmark Index	These reflect the overall market performance.	Nifty 50, Sensex
Sectoral Index	They track specific sectors like banking, IT, or pharma.	Nifty Bank, Nifty IT
Thematic Index	Follow specific themes like ESG (Environmental, Social, and Governance).	Nifty 100 ESG Index
Market Capitalization Index	Classify companies based on their market capitalization.	BSE MidCap, BSE SmallCap
Strategy Index	Formed using specific investment strategies.	Nifty Alpha 50, Nifty Low Volatility 50

Stock Market Index Formation

A stock market index is formed using several methods. Primarily, market capitalization is used to create an index. The different stock market index formation methodologies are discussed below:

1. Free-Float Market Capitalisation

This method is used for Sensex and Nifty. It calculates the index based on the total value of publicly available shares.

Formula: Index Value = [ ∑ (Free-float Market Capitalization of Each Stock)/Base Market Capitalization ] ×Base Index Value

Example Calculation: 

• Assume the free-float market capitalization of all Nifty 50 companies is ₹80 lakh crore.
• The base market capitalization is set at ₹10 lakh crore when the index started.
• The base index value is 1000.

Nifty 50=(80,00,000/10,00,00​)×1000=8000

This method excludes promoter-held shares. It better represents the actual market movements.

2. Price-weighted index

With this method, the index is calculated based on stock prices rather than the market capitalization. Stocks that have a higher price tend to have more impact on the overall index.

Formula:

Index Value = ∑(Stock Prices) / Number of Stocks

Its limitation is that the highly priced stocks will influence the index irrespective of the market situation. 

3. Market Capitalization Weighted Index

It uses the total market capitalization of involved stocks. It is a more comprehensive way but overrepresents larger companies.

Why does calculating the index matter?

• It ensures transparency while tracking market performance.
• It helps in the formation of index funds and track the performance of their funds against them.
• It acts as a one-step for investors to understand the performance and trends of the stock market.

Most of the Indian indices like Sensex, and Nifty 50 use the free float market capitalization method.

Stock Market Index Uses

Stock market indices are used for different purposes. It is a tool for investors, fund managers, and analysts to track the markets. Major uses of the stock market index are mentioned in the table below:

Market performance Indicator	Gives a snapshot of market performance. Helps to determine the bullish or bearish direction. Examples: Nifty 50, Sensex.
Benchmarking Investment Performance	The index is used as a benchmark to keep track of the performance of major funds like mutual funds, index funds, etc. Mutual funds use benchmarks like Nifty 50 for large-cap funds and BSE MidCap for mid-cap funds.
Investment Decision Making	It helps make active investment decisions. A rise in index value can indicate a good time to invest while a falling index can act as a caution to investors.
Basis for Index Funds and ETFs	Exchange Traded Funds (ETFs) and index funds use major indices for their formation. Example: Nifty 50 Index Fund.
Sectoral and Thematic Insights	Sectoral indices can indicate the major changes happening within a specific industry. Thematic indices like Nifty ESG 100 help in ethical investing
Economic Indicator	The stock market index can often reflect economic performance.
Market Sentiment Analysis	The index is a great way to assess market sentiment. A rising index indicates a positive market sentiment and vice versa.
Regulatory and Policy Framework	Government bodies such as SEBI can track the indices to ensure fair operation of the stock market.

Final Thoughts

Indices in the stock market are essential for market participants to make better trading and investing decisions. Not only that they are great for seeking the long-term growth potential of the country’s economy amidst the business landscape.