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What Do Stock Market Indexes Say About Investing

There is a saying that if you keep your ears to the ground, you may pick up valuable tips, and another which states that sometimes the best and most valuable nuggets are hidden right in front of us.

What Do Stock Market Indexes Say About Investing

This holds true if you are looking to garner valuable information from market indexes. Indexes are statistical measures indicating changes that are taking place throughout stock markets. For creating an index, similar types of stocks are selected from securities already listed on the same and grouped in the same classification band.

Stocks may be selected on the basis of the industry type, market capitalization levels, company size, and so on. The value of stock market indexes is computed on the basis of underlying stock values. Changes in the stock prices will naturally affect the overall index value greatly. If prices of a large number of underlying securities go up, then there will be a rise in the index and vice versa too!

Hence, stock market indexes say a lot about investing and the trends that hold good in the stock market. Their importance is unparalleled, to say the least; they reflect overall sentiments in the market, directions of prices, and their movements throughout commodities, financial, and other vital markets.

Simply tracking Sensex today will give you access to a wealth of valuable information that will further your own progress as an investor. Some of the key indexes in India include the following:

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  • BSE Sensex and NSE Nifty are benchmark indices.
  • BSE 100 and Nifty 50 are broad-based indices.
  • Market capitalization indices like BSE Midcap and BSE Smallcap.
  • Nifty FMCG Index and CNX IT among other sectoral indices.

Why are stock indices so important?

  • The stock market index functions like an indicator or barometer indicating overall market conditions while facilitating investors greatly for the identification of market patterns and shifts.
  • The stock market index will be taken as the reference by investors for choosing the stocks that they will invest in.
  • Thousands of entities are listed on the exchange and choosing the right one may be a nightmarish affair! Without any benchmark, you cannot differentiate properly between stocks. The index helps in classifying stocks and companies on the basis of diverse parameters, helping in stock pricing and identification.
  • Indexes are representatives of market trends and fill up knowledge gaps of people investing in stocks. The benchmark indices clearly indicate overall stock market performance.
  • Prior to investing in any stock, you will naturally want to ascertain whether it is worth the money you are paying for it or not. By comparing it with the index, you can easily ascertain its performance. If the returns are higher than the index benchmark, it has outperformed the same. If they are lower, then it has clearly underperformed the index. You will thus want to invest in a multi-bagger for justifying the risks involved. You can also choose investments in professionally managed and low-cost index funds.
  • Whenever you are participating in equity market investments, you should clearly know about sentiments prevailing in the market. This is because sentiments go a long way with regard to impacting overall demand for any particular stock and this impacts overall pricing as well. For investing in the best possible stock, you should know the reasons behind the fall/rise in prices of the same. Indices help in ascertaining investor mood and sentiment. You may also spot sentiments of investors for any particular market capitalization level or sector via indices.
  • Passive investment is where you invest in building a portfolio of securities that help in the replication of stocks within the index. Investors desirous of cutting down on research and stock selection costs may invest in the index portfolios likewise. Subsequently, returns on the portfolio will be similar to those of the index. If the portfolio is similar to the Sensex, for instance, then his/her portfolio will deliver approximate returns to the tune of 8% whenever the Sensex itself earns returns of 8%.

An index or indices is created from a group or set of similar stocks on the basis of various factors like industry or business sector, size of the company, and market capitalization among other factors. Upon stock selection, the value of the index will likewise be calculated. Every stock will come with a different price and changes in price for one stock will not be proportionately equal to changes in prices for another one.

Hence, the index value cannot be ascertained as a single figure that adds up all prices of stocks. This is where you should realize the importance of giving weights to stocks. Every stock within the index gets a specific weightage on the basis of price or market capitalization. This weight is representative of the extent of an overall impact on index value due to the changes in stock prices.

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