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Index and Sectoral Indices



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Stock market traders and investors often hear and use the term Index.

Let us get to know about what an Index is today.

An Index is a

.. list / collection of specific shortlisted companies

.. sharing certain common attributes

.. reflecting the security markets, market segments, or asset classes

.. and is maintained by the stock exchange

Nifty 50 is generally considered the representative for the market.

Nifty 50 is a collection of Top 50 stocks in the stock market ordered by its Market Capitalization.

S & P is the name of the company that helps BSE prepare the index every 6 months.

S & P stands for Standard & Poor. It is a global securities indexing company.

Direction of the market

Is the market going up or down? How is the market so far today?

If someone asks you this question, you should see the value of Nifty.

Nifty? What is it?

Nifty is Nifty 50, an index of top 50 stocks in the market.

Now, how to check value of Nifty?

You can get it from NSEIndia.com or from your favorite stock market app such as MoneyControl or EconomicTimes.

You will see something like: Nifty is at 8,678.25 down by -33.10 points or -0.38% compared to yesterday's closing.

Why should we track the direction of Nifty?

The direction of the market might give an indication as to in which direction the market is going.

It started in negative territory and went on slopping and ended in the red (loss).

Started in the negative territory? Really?

How to know this?

Go to Google Finance charts. http://www.google.com/finance?q=nse%3Anifty

Zoom to 1Day (1d)

From the chart, we can see, Nifty started the day way below the red line.

The red line is the previous day closing.

You can see that Nifty moved up and down and finally closed the day in the red.

Broad-market Indices

Remember, earlier we saw Sensex/100, Sensex/200, Sensex/500 etc.

Sensex/100 comprises top 100 stocks of BSE ordered occording to their market capitalization

Similarly, Sensex/200 comprises top 200 stocks of BSE and so on.

These are called Broad indices or Broad Market Indices.

These are important for the investor because they denote the direction of the stock price moment of their underlying companies.

Other type of Indices

Apart from Broad indices, there are other type of indices that stock exchanges track.

1. Sector & Industry Indices

2. Thematic Indices

3. Strategy Indices

4. Sustainability Indices

5. Volatility Indices etc.

Sectorial / Thematic Indices

In our clasess, we shall focus on Sector & Industry Indices now.

Let us take the S&P BSE Basic Materials.

S&P BSE Basic Materials is a Sectorial index.

It comprises some important stocks from that particular sector.

Now, you start using Sectrol indices when you want to stock pick from a specific sector.

In one of our previous exercises, we took the list of Top 100 stocks and searched them in BSEIndia.com to get the Industry / Sector names

In some cases, we need to the reverse exercise.

For instance, i want to invest in an Auto stock.

Instead of going through the whole list of Top 100 or Top 200 or Top 500 names, i better start with only the list of Auto stocks.

The list of such stocks will be available on BSE and NSE

.. in the form of Sectorial / Thematic Indices

Take a look at such indices:

  • S&P BSE Basic Materials
  • S&P BSE Consumer Discretionary Goods & Services
  • S&P BSE Energy
  • S&P BSE Fast Moving Consumer Goods
  • S&P BSE Finance
  • S&P BSE Healthcare
  • S&P BSE Industrials
  • S&P BSE Information Technology
  • S&P BSE Telecom
  • S&P BSE Utilities
  • S&P BSE AUTO
  • S&P BSE BANKEX
  • S&P BSE CAPITAL GOODS
  • S&P BSE CONSUMER DURABLES
  • S&P BSE METAL
  • S&P BSE OIL & GAS
  • S&P BSE POWER
  • S&P BSE REALTY
  • S&P BSE TECK

So, if i want to track only the Auto sector, i better check the S&P BSE AUTO index alone.

In later sessions, i will tell you about benchmarking.

In that, we attempt to compare our chosen stock with that of the Index.

For instance, assume my chosen stock is, say, Bajaj Auto. I want to find out if it performing better than Nifty 50, Sensex 100 or BSE AUTO

In our earlier classes, we have short listed our fixious Auto stock that could be worth investing in.

If we closely notice, the company is part of Nifty 50 Index.

It is called a benchark index. A yard stick to compare with.

So, Nifty 50 contains 50 companies... those top 50 companies in the order of their market capitalization.

Now how is the Nifty value fixed ? Based on overall share values ?

Yes. Overall value of the Top 50 shares by market cap.

The top 50 shares are so dominate that they rule the direction of the market.

Overall value in what term bro? Addition of cmp of nifty 50 stocks? Will 50 stocks average make nifty ?

We shall now look a bit about Nifty 50.

Remember it is an index, a reference point that tells the direction of the market.

Method of Computation of Nifty 50

Nifty 50 is computed using free float market capitalization weighted method, wherein the level of the index reflects the total market value of all the stocks in the index relative to a particular base period.

The method also takes into account constituent changes in the index and importantly corporate actions such as stock splits, rights, etc without affecting the index value.

Impact of Addition / Removal of a company from the Index

Question: What will be the impact of a company getting added / removed from an Index?

Our stock market has several types of indices.

Much of the attention will be on Market cap / broad market indices such as BSE Sensex, NSE Nifty etc.

There are other type of speciality indices such as Sectorial / Industry indices such as BSE Basic Materials, BSE Energy etc. and Thematic indices such as BSE India Infrastructure index, BSE 500 Shariah etc.

When a stock gets added to an index, it can be considered as a positive development.

There are four advantages to this:

1. Immediate upward movement of price of the stock because of the inclusion.

2. Increased liquidity in the stock which means increased market cap for the stock.

3. Increased coverage and attention by analysts and brokerage companies. This will mean more retail and institutional participation.

4. Institutional investors such as Mutual funds, pension funds will consider investing and tracking indices depending on their focus / chosen market caps / sectors. For instance, a mutual fund scheme such as BOI AXA Manufacturing & Infrastructure Fund will have a mandate to only track and invest in companies listed in S&P BSE India Infrastructure and India Manufacturing Index.

Similarly, when a stock is removed from an index, it is considered negative because slowly, the focus and attention on the company in the market fades down.

A research was conducted on the topic The Impact of Adds and Deletes on the Returns of Stock Indexes ( http://www.haas.berkeley.edu/MFE/download/student_papers/mfe02_quinn_wang-impact_add_deletes.pdf ) by Jim Quinn & Frank Wang. Some findings from it and related studies say that:

1. Excluding a stock from the index results in a price drop. The price drop was attributed to an expected decrease in the quantity and quality of future analyst coverage for these stocks - Goetzmann and Gary (1986)

2. Abnormal returns from stock inclusion in the S&P 500 seem to have grown over time, parallel to the growth of index funds - Schleifer

3. Prices of stocks added to the S&P 500 index increased by more than 3% after the addition is announced, and the increase in price is nearly fully 40 reversed after 3 weeks - Harris & Gurel (1986)

4. On average these firms earned a large positive 3.07% excess return on the day following the announcement - Jain (1987)

5. The observed small net change in institutional holdings following listing on the S&P 500 index suggests that the require d liquidity resulting from the demand of index funds is being supplied by other, non-index institutions - Pruitt and Wei (1989)

6. The price pressure effect is a temporary effect and the liquidi ty effect is a long-term effect (improved liquidity resulting from being part of the index) - Madhaven (2002)

The impact on a stock will be substantially more when added to a broader index (such as, say, NSE Nifty) compared to that on a Sectorial index (such as, say, BSE Energy index).

Criteria for inclusions / exclusions from the Index

  • Question: What is the criteria of companies getting listed in Nifty 50 and Sensex? Is the same criteria applies for BSE small cap and other indices? Further, on what basis does some companies get de-listed from Nifty 50? How often does the NSE reviews this procedure or come to a conclusion that a company is not complying the requisites and to be removed from Nifty?*

There are several rules that companies should follow so as to get listed, and once-listed so as to not get de-listed on the stock exchanges.

The criteria is a little complex, but if you are interested, please read: https://www.nseindia.com/getting_listed/content/eligibility_criteria.htm

The index, such as Sensex 30, Nifty 50, Sensex 100 etc. are revised every quarter.

For Sensex 30, the list of all shares are put in the order of their market caps and the top 30 companies will make it to Sensex 30.

Different indices has different criteria. IISL is the company that maintains list of indices for NSE.

Please read their method of computation for broad indices from https://www1.nseindia.com/content/indices/ind_meth_broad_indices.pdf

Assignment 1

Try to guess what type of stocks fit each of the above BSE Sectorial indices.

Assignment 2

Open each of the Sectorial index and try to get familiar with atleast 3 to 5 stocks from each of them.

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