Stock Market Index captures the overall picture of the stock market . It is created through the selection of a set of stocks out of the whole array which can represent the mood of the overall market or a segment of the market or a specific sector. Stock market index works as a source of information for the economy as a whole.
Stock Market Index is based on the statistical compilations of the prices of the representative set of stocks and reflects a composite value of its component stocks. All the stocks in an index have some common traits such as stocks belonging to the same industry or stocks of similar market capitalization.
Stock Market Index gives a composite idea about the relevant market.
It literally means “numerical scale used to compare variables with some reference number”. It gives an overall idea about the economy in general and a sector in particular. Index is a very useful tool for comparing the performance of an equity fund .
Stock Market Index gives a comparative idea on the expected return potential of the money invested in the stock market and other investment avenues such as gold, real estate, bonds, etc. This helps the stock market investor to get a clear idea on the opportunity cost of his money.
Stock Market Index particularly tries to capture the effects of the country related news on the expectations of the overall market. Stock Price move due to two main reasons :-
Specific news about the company (quarterly report of the company)
(b)News related to the country as a whole (any action taken by the apex bank such as increase or decrease of bank rate).
Every stock movement is affected by a bit of both the above factors. In the process of construction of index by means of averaging, the company specific news are averaged out and the only thing remains is the news common to all the stocks (which is the news related to the country). The right process of construction of an index is to take a weighted average and assign a weight proportional to its market capitalization .
Indexes are of two type :-
- Broad Market index
- Specialized index
Broad Market index includes all type of stocks ranging from large to heavyweight to liquid. Specialized index on the other hand are tries to capture the mood of a particular sector such as IT index, Auto index, etc.
New derivative instruments based on indexes (such as Index Fund s, Index Option s, Index Future s) help in risk management and financial investments.
Hence it can be concluded that
Stock Market Index plays the important function of giving an overview of the market as a whole and facilitates the investors for gauging the overall mood of the market. This helps an investor to take informed decisions and act accordingly for closing a profitable.