Do stock indices tell the right story?

Stock market indices, as we have explained earlier, gives you a snapshot of how the economy is going forward.It’s just a snapshot.

If you look at the total number of companies listed in the BSE, it is above 6500. The Sensex however, tracks only 30 of the most liquid stocks based on their selection criteria. That’s approximately 0.45% of the total companies listed.  Similarly NIFTY tracks only 50 of the most liquid stocks based on NSE’s stock selection criteria. So, the market index represents only a very small section of the stocks and these 30 or 50 companies unfortunately may not be a correct representation of the market. There are many niche sectors that are not represented in the index.

The first eight companies in the Sensex have a weightage of more than 50% in the index. If these eight companies move in one direction, the index would be in green, even if all others don’t perform. So if the index rises, it is not necessary that your investment would also rise.

However, if you are holding shares in the exact ratio of an index (that is, if you have mimicked the index with a smaller amount) following the index may make sense.

Hence, stock indices are unimportant to an ordinary investor. What’s important is to pick stocks that are fundamentally good. Fundamentally good stocks perform well in any situations. There are many stocks which steadily rise, unnoticed by many, when the market index is going no where.

If you need a barometer to check the pulse of the market, there are some broader indices such as BSE 200 and BSE 500, which represents 200 and 500 companies respectively. These indices should be better than the Sensex and the nifty since, a lot companies from many wide sectors are included.

If you want to track a particular sector, like banking or technology, Sectoral indices are available from the BSE and NSE. This too, works well.

USES OF AN INDEX.

Indexes are however, used a proxy for investor confidence in equity markets.

Investors, who are not good in analysing fundamentals, but wants to put their money in the best companies around can track changes in the indices and take decisions.

Those who feel that they cannot beat the index can invest in Index based mutual funds, which actually track the performance of the index and allocates money in the same ratio as the index. It is a good option for those who wants keep their money growing exactly like the index.

Indices can be used to measure and compare the performance of individual stock portfolios.

Last but not least, they can be used to check how the market reacted to specific events like terrorist attacks or earth quakes and that will help you to forecast how the market would behave , should such a disaster happen again.

You may like these posts:

  1. What is a stock index?
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  3. What is nifty? How is it calculated?

3 Responses to “Do stock indices tell the right story?”

Aira

September 21, 2011 at 5:34 pm

I Appreciate this information .

Vaibhav

March 19, 2013 at 9:18 pm

Thank you for this valulable information

Lijin RT

August 12, 2016 at 6:03 pm

Very informative and brief explanation of every article. Thank you…

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