Nifty and Sensex these two words has become almost synonymous to the Indian stock market. Everyone from news anchors, market experts to influencers talks about it. Infact nifty is one of the most tracked indices in the world. As an investor or trader in the Indian stock market, you must understand what it is, how it is constituted, and what role it plays. But before we proceed any further on what is Nifty and Sensex let us explain what an Index is.
What is an Index?
An index gives an overall idea of the stock market performance. It gives us an updated and accurate representation of market sentiment. So, if an index is going up it would typically mean that investors are bullish. If it goes down it would mean that investors are bearish. Index can represent a specific sector of the economy or overall economy. It depends on what it is designed to represent. If it is sector based it would track the performance of stocks of that specific sector. If it is a broad economy based it would track the major stocks of the economy. Hence think of the index as a package of stocks. The stocks are chosen after they meet certain criteria.
How is Index Constructed?
An index consists of similar stocks based on the theme. This could be on the basis of market capitalization, industry, sector or any other parameter. As we discussed earlier, to include a stock in the index it should qualify certain criteria. Once it qualifies as an index stock, it should continue to qualify on the required terms. If it fails to maintain the terms, the stock gets replaced by another stock that qualifies the prerequisites.
After stock is selected on the basis of selection process, it has to be assigned a certain weightage. Weightage, in simpler terms, defines how much importance a certain stock in the index gets compared to the others. For example, HDFC BANK has a 9.23% weightage in the Nifty 50 index, it is as good as saying that 9.23% of Nifty’s movement can be attributed to HDFC BANK. There are many ways to assign weights. But the two most common kinds are Price weighted and market capitalization weightage.
Market Cap Weightage:
The total market value of a company’s stock is market capitalization. Market capitalization is the product of the total number of shares outstanding in the market and the stock price. In an index which is based on market capitalization, stocks are given weightage depending on their market capitalization in comparison to the total market capitalization of the index.
In India, most indices are based on free float market capitalization. This is a variant of market capitalization. In this method, instead of using the total shares listed by a company, only the number of shares publicly available for trading are used to calculate the market capitalization. Some examples are S&P 500 of the US, Nifty and Sensex of India.
In the price weightage method, an index value is calculated on the basis of only the company’s stock price. It does not include outstanding shares; hence no market capitalization is used here. Stocks with higher prices are given greater weightage in the index than stocks with lower prices. Examples of these types of indices are the Dow Jones Industrial Average of the US and the Nikkei 225 of Japan.
There are also other kinds of index weightage criteria, but they are rarely used.
What is Nifty?
Now that we have understood what an index is, we move on to learn what is nifty? Nifty is an Indian stock market index launched by NSE (National Stock Exchange). It is combination of two words ‘National stock exchange’ and ‘Fifty’. It represents the weighted average of 50 of the largest Indian companies listed on the NSE. Nifty is a very popular stock index in India and across the world also. The index’s constituents come from a variety of industries, 14 in all, and are intended to represent Indian stock market as a whole.
What are the stock selection criteria of Nifty?
Now that you know what NIFTY is, let’s look at what it takes for a company to be eligible for inclusion in the index. To be evaluated by the NSE for the NIFTY index, a company must meet the following qualifying criteria.
- Stock must be listed on the NSE and be available for trading in futures and options on the NSE.
- The registered office of the company should be in India.
- Large-cap stocks
- Liquidity is abundant.
- High volume
There is no company that has a permanent place in the NIFTY index. Every six months, the index managers and advisory committee recreate the index. At the time of reconstitution, index managers examine whether the index’s current constituents continue to meet all of the conditions and eligibility criteria. If any of the NIFTY stocks fail to meet even one of the criteria, it is removed from the index and replaced with another company.
How is Nifty calculated?
Nifty is determined using the free float capitalization-weighted technique for all 50 companies.
Market capitalization equals the current market price multiplied by the number of outstanding shares.
The Index’s base market capitalization is the aggregate market capitalization of each script in the Index during the base period. The market capitalization is equivalent to an index value of 1000 during the base period, which is known as the base index value.
Market capitalization in free float = shares outstanding * price
Index Value = (Current Market Value / Base Market Capital) * Nifty Base Index Value (1000)
What is Sensex?
The Sensex is index of Bombay Stock Exchange (BSE) which is India’s oldest stock exchange. It consists of a total value of 30 equities from companies listed on the BSE. Indeed, these stocks belong to India’s largest corporations and thus represent the overall performance of the Indian economy. The movements of the Sensex are tracked on a regular basis, which aids in the analysis of overall growth and industry-related development.
What are the stock selection criteria of Sensex?
Like NSE there are also stock selection criteria of BSE which is very much similar also. The following are the criteria utilized in determining the Sensex’s 30 stocks:
- The stock must be traded on the BSE.
- Stocks with a large market capitalization.
- Liquidity is abundant.
- Daily average turnover.
- There is widespread industry representation.
How is Sensex calculated?
The Sensex, or sensitivity Index, is computed using the free-float capitalization of all 30 firms and the Sensex’s base value. Here’s a step-by-step guide on calculating the Sensex –
- 30 companies’ market capitalizations are computed.
- The total free-float capitalization value is calculated by estimating the free-float capitalization of all companies and adding them together.
- Use the Sensex calculation: Sensex formula = (Free float market capitalization of 30 firms / Base market capitalization) * Index base value.
In the world of finance, an index is a subset of the stock market that helps determine the overall performance of the stock market. In India Nifty and Sensex are the two major broad market indices. The primary distinction between the Sensex and the Nifty is the number of stocks that are bundled together. For index purposes, the Sensex examines 30 firms, whereas the Nifty considers 50.
We hope you now know what is Nifty and Sensex and have a clear idea of the stock market index too. Share this article with your friends. And comment any further queries you might have in the comment section. Happy Learning