Market Index
Market Index, also known as a stock index, is a statistical measure that represents the changes taking place in the market. A few similar stocks among the securities listed on the exchange are grouped together and it is taken as a sample to represent the performance of the whole market. In simple words, this sample is known as an Index. Change in prices of underlying securities ( stock, bond, currency, or commodity on which derivative instruments, such as futures, ETFs, and options, are based) impacts the overall value of the index. If there is a rise in price the index will rise, and if they go down, so will the index.
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Needs of Indices:
Market Index acts as a barometer that is required to know the mood and sentiment prevailing in the market by showing the overall conditions of the market. It helps the investors in identifying the ongoing pattern of the market, which in turn helps the investors in deciding and making informed judgments.
Importance of Stock Market Index:
- Aids in the Stock-Picking: The market index acts as a benchmark that helps to differentiate between the stock. It not only helps with sorting but also classifies the companies and their shares based on key characteristics like the size of company, sector, industry type, and so on.
- Acts as a Representative: They indicate the performance of the entire stock market and also help to fill the knowledge gaps that exist among the investors. They act as a representative of the particular industry we want to invest in.
- The Parameter for Peer Comparison: It helps compare a stock’s performance with the underlying index, which in turn helps the investor to easily judge the performance of a stock.
- Reflects Investor Sentiment: Indices help to gauge the mood of investors because the sentiment affects the demand for a stock which in turn impacts the overall price.
- Helps in Passive Investment: When an individual invests in a portfolio of securities that replicates the stocks of an index which will help to cut down on the cost of research and stock selection prefer to invest in an index portfolio.
Functions of Indices:
- Benchmarks: Since investors can not invest in an index directly, they use indices as broad benchmarks for price movements of individual securities. It also helps in determining the commission paid to fund managers.
- Diversification: Investors choose to diversify their exposure to multiple indices which enables optimizing returns while being exposed to a minimal degree of risk.
- Segment based investment: Using indices helps investors in investing in emerging sectors with high growth potential.
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How are indices weighted?
Since the price of the stock keeps changing it is difficult to arrive at a simple index value and here is when the importance of assigning weights to stocks comes into play. Each stock in the index is assigned a particular weightage on the basis of its market capitalization or price. The weight represents the extent of the impact that the change in the price of a stock has on the value of the index.
The commonly used stock market indices are:
- Market-cap weightage: It means the total market value of the stock of a company. When the total number of outstanding stocks floated by the company are multiplied by the share price of a stock, we get the market capitalization of that stock. It keeps on changing every day with the fluctuation in stock price.
- Price weightage: Here the value of an index value is computed based on the stock price of a company. The higher the price of the stock, the higher will be the weightage and vice versa.
Interesting Fact:
Suppose a stock has a market capitalization of Rs.50,000 where’s the underlying index has a total market cap of Rs.1,00,000. Thus 50% weightage would be given to the stock.
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Examples:
Some of the market’s leading indexes include S&P 500, Dow Jones Industrial Average, Nasdaq Composite, S&P 100, Russell 1000, S&P MidCap 400, Russell Midcap, Russell 2000, S&P 600, U.S. Aggregate Bond Market, Global Aggregate Bond Market.
Author: Mahek Medh
About the Author: Currently, I am in my second-year bachelor’s program and over the period of time I have realized that I enjoy learning about numbers and money, and I find topics of Finance to very interesting thus this is the domain and space where I wish to etch my long term career.
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