Business Basics and Management Mantras Taking Stock of Stock Market-Making Sense of Sensex-Part-1

 | April 08,2010 05:29 pm IST


Whether Boom or doom, educated or the normal trader the word SENSEX and NIFTY have become the daily mantra.Since the last few years the value has more than doubled and the last one year it has plummetted at the same speed.

The devastating days of September 2008 are now a distant memory. A year on from Lehman, Indian companies are back to raising money and industrial production is climbing up. As animal spirits return with a vengeance and the market starts to get its daily doses of greed, investorsand traders are keeping a close watch on the Sensex. But trying to track the future direction of the market is an arduous task. Upswings and downswings—the rollercoaster ride can be challenging.

During the last few months, the sensex gained in 14 of the 20 session and added 1,461 points, or 9.3%, to 17,127. Brokers and dealers admitted that much of these gains came on the back of liquidity, the inflow of money from abroad.

Let us understand about the concept of stock market index and the main indicators such as SENSEX and NIFTY.

Importance of Stock market index
On a day to day basis the media speaks about the Sensex movement. Let us understand this important measurement. At the outset let us understand that any good stock market Index reflects the behaviour of Equity Markets as a whole. A good stock market Index should efficiently reflect the underlying universe that it represents.Thus it serves as a good investment benchmark for portfolio managers,FII’s and retail investors.A stock market good index is genrally considered as a reflection of economy.

SENSEX - The Barometer of Indian Capital Markets

SENSEX, first compiled in 1986, was calculated on a "Market Capitalization-Weighted" methodology of 30 component stocks representing large, well-established and financially sound companies across key sectors. The base year of SENSEX was taken as 1978-79. SENSEX today is widely reported in both domestic and international markets through print as well as electronic media. It is scientifically designed and is based on globally accepted construction and review methodology. Since September 1, 2003, SENSEX is being calculated on a free-float market capitalization methodology.

The "free-float market capitalization-weighted" methodology is a widely followed index construction methodology on which majority of global equity indices are based; all major index providers like MSCI, FTSE, STOXX, S&P and Dow Jones use the free-float methodology.The growth of the equity market in India has been phenomenal in the present decade. Right from early nineties, the stock market witnessed heightened activity in terms of various bull and bear runs. In the late nineties, the Indian market witnessed a huge frenzy in the 'TMT' sectors. More recently, real estate caught the fancy of the investors.

SENSEX has captured all these happenings in the most judicious manner. One can identify the booms and busts of the Indian equity market through SENSEX. As the oldest index in the country, it provides the time series data over a fairly long period of time (from 1979 onwards). Thus SENSEX has become one of the most prominent brands in the country.

Further the qualities which make SENSEX a successful and prominent indicator are

A portfolio of quality Blue Chip companies
The only broad based Free-Float weighted index in India
A good proxy for overall market movements
Reliable benchmark for Fund Performance
A Good Hedging Tool
It is not easy to manipulate

What is a Index
An Index is an indicator that is designed to summarize the price behaviour of unique set of MKt goods E.g.,
- WPI- wholesale prices of commodities,
- CPI- measures rate of inflation/ deflation

Index number shows comparison with a base period and Base Value e.g., Base Year 1980, Base value: 1000
In Stock Market context, an Index represents the price behaviour of equity market.

Further the movement of a stock Index is incluenced by varoius factors generally there are three types of news which affect stock market

a. Company Specific news
- Affects the valuation of only that company
b. Industry Related news
- Affects all the companies in that industry.
c. Economy Related news affects all companies

Parameters for stock Selection
An Ideal Index

Should have sufficient no.of companies to neutralize the impact of company Specific News
Should be well diversified across sectors so as to neutralize the impact of Industry related News
What remains is Market Risk or economy Related News which affects all the companies equally- Index should reflect this Market Risk.



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Vikram Sharma on 10/10/10 at 02:31 am

Thank you Mr.M.Guruprasad. This is one of the best article I have ever read.