SHARETIPSINFO >> Articles Directory >>Stock market index and types of Indian stock market index
Stock market index is a method for measuring a certain section of the stock market. The stock index is used to benchmark the performance and the position of the stock market. Basically the stock index sums up the overall performance of the stock market on a daily basis. There are certain criteria on the basis of which the value of the index is determined. The method that is applied for determining the index also determines the type of the index.
Generally there are two types of stock market index.
Broad Market Index – This type of index is made with the stocks of the large companies that are listed in that market. Generally the liquid stocks of the most reputed companies are considered for making the index. Most of these stocks that are part of the market index are premiere companies among the listed companies in that exchange. These stocks are selected from different sectors so that the index maintains equilibrium among the sectors.
Specialized Index – There are some indexes that are based on specific sectors. These sector based indexes are made with the premiere companies from that sector. The highly liquid stocks from the sectors are selected to make the specialized sector.
There are so many parameters that are considered for making the indexes and they are,
Liquidity of the stock – Generally the highly liquid stocks are considered for including in the index. The impact cost of the stock is the determining factor for the liquidity of the stock. The impact cost is determined by the cost that is paid by the trader when actually trading that stock. If a stock costs 200 in the market but when the stock is bought by the trader he is paying 202. Then the market impact cost of the stock will be 1% and this stock will be considered as a highly liquid stock because of the lower impact cost of the stock.
Diversification of sectors – While constructing the index and selecting the stocks for making the index it is maintained that the index has a balanced representation of all the sectors from the listed companies. This is done to reduce the stock noise of the index. That means a debacle in a certain sector would not adversely and intensely affect the index as a whole. That is why top companies from different sectors are selected to construct the index.
Optimum Size of the index – More number of stocks in the stock index surely reduces the level of risk for the investors. But beyond a point increasing the number of stocks in the index hardly has any effect on the index. Moreover, when more number of stocks is included in the index there is a chance that stocks that are not liquid in nature is included in the index. So it is important to determine first the number of stocks that is perfect for the index. This is done by the determining the optimum size of the index.
Market capitalization of the stocks – Generally for constructing the index the stocks with large market capitalization are selected. Large companies that are listed in that stock exchange are considered for making the index. This ii primarily done to ensure that whenever there is major change in the price of that particular stock that change is reflected to the index. So it is the primary concern for selection of the index as that would actually make sure that the index of the market portrays the market position.
Averaging of the stocks – The price of the stock and the position of the index is influenced either by the price of the company or the condition of the economy of the country. While making the index it is important that the averaging of stock is done in way that will minimize the effect of the price of one stock on the index. It is a process in which it is ensured that the index reflects the condition of the economy rather than the position of the company.
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