Ask any casual observer of Indian financial news to name a stock market indicator, and two names will almost certainly come up: INDEXBOM: SENSEX and INDEXNSE: NIFTY_50. These two benchmarks have become so deeply embedded in everyday conversation that they appear in television tickers, newspaper front pages, and even casual dinner table discussions about the economy. Yet despite their constant presence in public discourse, many people who follow these numbers daily don’t fully understand what they represent, how they’re calculated, or why two seemingly similar benchmarks exist alongside each other in the first place. This article aims to clarify these fundamentals in accessible terms.
The Origins and Purpose Behind These Benchmarks
India’s two main stock exchanges have unique benchmark stock market indices. Both were developed at different times and, at first glance, have nothing to do with each other. However, the two numbers reflect a somewhat similar picture of the situation in the market. One of them, reflecting the work of the oldest exchange, is popular in the market among older investors, and the other has been created relatively recently and among young people, it is increasingly being perceived as a standard.
Both indices include a set of leading companies’ shares for different sectors, from banking to technology. For the two indices’ baskets, companies are selected that have a good reputation, high market value, and sufficient reputation as an OTC dealer. The components of the baskets are changed, updated, and optimised over time; for example, to exclude companies whose market value has decreased. Such changes may seem insignificant, but they are essential for the index’s value to accurately reflect the situation in the market.
The indices’ calculation method is also critical, which implies that changes in the value of even a few companies can affect their overall value. Market value is used as a reference measure, which means that the larger the company is, the more weight it has in the index. Understanding how the indices work is needed because, due to the peculiarities of the methodology, significant changes in the value of several large companies can significantly affect the value of the index, even if relatively small companies.
Why Two Indices Exist at the Same Time
Most often, new investors’ questions focus on why there are two indices when, at first glance, one could do. As mentioned earlier, each index characterizes the work of stock exchanges that belong to different owners. However, the indices’ values are so closely intertwined that it is hard to imagine how the slightest change in the value of the basket of the first exchange impacts the second one.
There is no fundamental difference between the indices that characterize the work of different exchanges; the number of companies in their baskets differs, which makes the indices vary slightly. This divergence occurs because the companies in the baskets represent different market weights. For example, when the market weights in the basket are small, such companies’ falls in value significantly affect the value of the index because of their high weight.
However, for the average investor, these differences probably do not matter at all. At the moment, there are different tools in the market, from investment funds to various exchange-traded contracts, whose work is based on the indices. At the same time, it is hard to find reasons why the choice of one or another index would be more advantageous for the investor in the long-term investment strategy. However, the situation is entirely different for the professional manager for whom the study of small differences between the indices is a routine task.
What Do the Indices Say to the Average Investor?
There are good reasons why an ordinary investor, who is just starting to invest in the stock market, should know about the existence of these indices and follow their changes. First of all, the use of this knowledge extends to the selection of specific instruments that copy the indices’ movements. Many funds use indices as a benchmark, and knowledge of their work allows the investor to choose the most cost-effective option available.
In addition, knowledge of the indices’ work can be useful in selecting actively managed funds, the performance of which must be compared with the indices. Using this information, an investor can single out those funds that do not justify their high costs, as, in the long-term investment strategy, they will be completely outperformed by cheaper and more accessible funds.
Moreover, knowledge of the indices allows the investor to get an idea of how much profit can be obtained over a long period of investing. In other words, the study of the course of the indices over a period of several years allows the investor to see average values over different periods, against the background of which specific stocks or indices rise or fall. However, knowledge of the history of the indices is useful not only for choosing tools for investing but also for assessing risk, which is critically important when making investment decisions.
Indices: Not Just Numbers
While these indices’ values often end up in the headlines, savvy investors know to look beyond the headlines and analyse the situation in the market. If the index grows rapidly, this indicates that more and more investors are optimistic about the prospects of the economy reflected in the index. However, if the growth is rapid only due to the growth of several large companies, this can speak of the opposite trend, while changes in a few small companies rarely affect the entire index’s value.
Understanding the nuances of how the indices work allows the investor to draw more accurate conclusions about how things are going in the market. However, such knowledge requires time and patience, as well as the study of materials related to stock market trading. However, once the investor realises how valuable the information about the peculiarities of the work of the leading market indicators is, they will further monitor and consider all the details of the work with stocks.
