All About Indices

Whether it’s vegetables, groceries, clothing, or fuel, we all notice that prices rarely stay the same. The reason? A mix of economic factors like supply-demand dynamics, inflation, production costs, and more. Now, imagine trying to track how prices of all these daily items have moved over a year. You’d have to check the price history of each item, figure out when it changed, why it changed—and still struggle to draw a clear picture. 

That’s where indices come in. 

An index simplifies this problem. It’s a statistical tool that captures and tracks price movements or values across a selected group of items over time. For example, the Consumer Price Index (CPI) indicates how consumer goods’ prices have changed from one year to the next. If the CPI was 150 last year and it’s 165 now, we can say that retail prices have increased by 10%. 

Indices are used across sectors to measure trends in: 

• Stock market prices 

• Cost of living 

• Manufacturing and agricultural output 

• Imports and exports 

In the context of stock markets, indices are essential. They help understand market direction, assess portfolio performance, and guide investors in decision-making. 

How Market Indices Work 

Let’s take a look at an example from the Nifty 50 index. 

Looking at the stocks individually gives you a mixed picture—some prices rose, others fell. But the Nifty 50 index moved significantly upward, suggesting an overall market uptrend in 2021. That’s the power of an index—it helps investors gauge the general mood and direction of the market, beyond individual stocks. 

How Indices Are Constructed 

Building a reliable and representative index requires choosing the right stocks based on specific criteria. Here's what goes into that selection: 

1. Regular Trading Activity 

Only actively traded stocks make it to an index. For example, companies must have a 100% trading frequency in the past six months to qualify for the Nifty 50. If a stock isn’t frequently traded, its market price doesn’t reflect its actual demand, potentially distorting the index. 

2. Free-Float Market Capitalisation 

The term “free-float” refers to shares that are available for the public to trade (excluding promoter holdings). A company with a larger free-float has more liquidity and influence in the index. To be included in the Nifty 50, a company’s average free-float market cap must be at least 1.5x that of the index’s smallest constituent. 

3. Liquidity and Impact Cost 

Stocks in an index must be highly liquid, meaning they can be bought or sold quickly without affecting their price too much. This is assessed via the impact cost, which shows the cost difference between expected and actual trade execution prices. Exchanges publish these figures monthly. 

Some exchanges have a waiting period before including new listings in an index, while others like NSE may fast-track inclusion within three months—provided they meet free-float and liquidity standards. 

Major Indices in India 

India’s two most prominent indices are: 

Nifty 50 (NSE) 

• Represents 50 top-performing stocks 

• Captures ~65% of the total float-adjusted market cap of NSE 

• Tracks the most actively traded and liquid companies in India 

BSE Sensex (Bombay Stock Exchange) 

• Comprises 30 of India’s strongest and most stable companies 

• Known as S&P BSE Sensex 

• One of Asia’s oldest and most recognized indices 

Points to Remember 

• Market indices are commonly used by institutional investors as benchmarks for evaluating performance. 

• Leading global indices also serve as reference points for asset allocation and portfolio performance reviews. 

• Passive investing—investing in index-tracking products like ETFs (Exchange-Traded Funds)—is rapidly gaining popularity.