Explained: Sensex, Nifty & Their Role In India's Stock Market

Sensex and Nifty are the two national stock market indices in India. Whether you are a keen follower of the stock market or in fact an investor in it, you are likely to have come across these two terms dominating the headlines of financial portals, business news channels and pink papers almost everyday.

So, what exactly are Sensex and Nifty? What is their role in the stock market?

Eager to know? Let's decode the concept of Sensex and Nifty for you.

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What Is Stock Market Index?

To understand stock market indices, you first need to know what stock exchanges are. Stock exchange, like BSE and NSE, is a platform where all tradable securities like shares, bonds, derivatives and commodities are listed.

So, a stock market index is an indicator of the performance of its respective stock exchange, which is representative of the performance of the portfolio of that section of the financial market or even the economy as a whole.

For example, ups and downs in NIFTY and/or Sensex may either be indicative of the performance of stocks in their respective portfolios and/or the prevalent condition of the entire financial market or even economy due to internal or external factors or both.

The reasons behind a stock market crash can be one or multiple, including an economic crisis, catastrophic events like a pandemic or natural disaster, or even the collapse of a long-term speculative bubble.

Understanding Sensex

The term Sensex comprises of two words - Sensitivity and Index, which are indicative of what Sensex reflects and calculates. i.e. the movements in the BSE. Sensex is the benchmark stock market index for BSE (Bombay Stock Exchange).

Founded in 1986, SENSEX is a free-float market-weighted stock market index that aggregates the movements of 30 well-established and financially sound companies listed on the BSE. These 30 companies are 30 of the largest and most actively traded stocks and are representative of various industrial sectors of the Indian economy.

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How are SENSEX constituents decided?

Broadly stating, there are 4 key criteria upon which a company has to qualify in order to be considered for inclusion in SENSEX.

These include: The company must be listed on BSE, must be a large or mid-sized company (as per market capitalization), it has to possess a high degree of liquidity of shares and maintain the sector weight balanced.

To deep dive and understand the calculation and other aspects of Sensex, click here.

How to invest in SENSEX?

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There are 2 ways to invest in SENSEX-

The first is by buying stocks directly in the same percentage as weightage in SENSEX. Through this route, you can directly start investing in the constituents of the SENSEX and the weightage they have in it. Simply put, you can directly buy the stocks in the quantity which is equivalent to the stock¡¯s weightage in the index.

The second way to invest in SENSEX is through Index Mutual Funds. These mutual funds replicate the index i.e, they have a portfolio exactly like the index. So a SENSEX-based index fund will have the 30 stocks in the same proportion as the SENSEX.

What do SENSEX movements indicate?

Simply put, if the Sensex climbs up, it implies a rise in the prices of the stocks of some or most of the major companies listed in the BSE. On the contrary, if the Sensex goes down, it indicates that the stock price of some or most of the major stocks listed on the BSE has gone down.

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Understanding NIFTY

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The term Nifty is derived from the combination National and Fifty, as Nifty consists of 50 actively traded stocks. Also referred to as NIFTY50, it is the flagship index on the National Stock Exchange of India Ltd. (NSE). The Index tracks the behaviour of a portfolio of blue-chip companies, the largest and most liquid Indian securities. It includes 50 of the approximately 1600 companies traded (both listed & traded and not listed but permitted to trade) on NSE.

NIFTY50 stocks represent about 65% of the total float-adjusted market capitalization of NSE.

It covers major sectors of the Indian economy and offers investment managers exposure to the Indian market in one efficient portfolio. The Index has been trading since April 1996 and is often believed to be well suited for benchmarking, index funds and index-based derivatives.

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Eligibility for inclusion in NIFTY

For a stock to qualify for inclusion in the NIFTY50, it has to qualify for certain conditions.

These include: Company¡¯s average free-float market capitalization has to be at least 1.5 times the average free-float market capitalization of the smallest constituent in the index; the security should have traded at an average impact cost of 0.50 % or less during the last six months for 90% of the observations for a portfolio of ? 10 crores; company¡¯s trading frequency should be 100% in the last six months. Besides these criteria, there are a few conditions pertaining to listing history too which a company has to qualify for if it has to become eligible for inclusion in NIFTY50.

Also, even after the construction of the index, it is reconstituted semi-annually considering 6 months of data ending January and July respectively. The replacement of stocks in NIFTY 50 (if any) is generally implemented from the first working day after the F&O expiry of March and September. In case of any replacement in the index, a 4 weeks¡¯ prior notice is given to the market participants.

Also, on a quarterly basis, indices will be screened for compliance with the portfolio concentration norms for ETFs/ Index Funds announced by SEBI on January 10, 2019.

Nifty Index Construction

The NIFTY 50 is computed using a float-adjusted, market capitalization-weighted methodology (from June 26th 2009), wherein the level of the index reflects the total market value of all the stocks in the index relative to a particular base period. The methodology also takes into account constituent changes in the index and corporate actions such as stock splits, rights issuance, etc., without affecting the index value.

And the base period for the NIFTY 50 index is November 3, 1995, which marked the completion of 1 year of operations of NSE's Capital Market Segment. The base value of the index has been set at 1000, and a base capital of ?2.06 trillion.

Now comes the price index calculation.

The NIFTY 50 is computed using the free-float market capitalisation weighted method wherein the level of the Index reflects the total market value of all the stocks in the Index relative to the base period November 3, 1995.

But w.e.f. February 1, 2018, SEBI has mandated that all benchmarks should be shifted from the Price Index to the Total Returns Index (TRI). This is because TRI is considered more accurate as it takes into account dividends as an assumed reinvestment into the index.

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Role of Sensex & Nifty

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As the two national stock market indices, Sensex and Nifty are used for measuring the overall performance of the stock market. Sensex is the index used by BSE and Nifty is the index used by NSE. The up and down movement in these indices reflect the movement in the portfolio stocks of that index and is often seen as an indication of the market sentiment.

Nifty and Sensex are also widely used as benchmarks for mutual funds to measure their performance. While some mutual fund houses may stick to Nifty as their benchmark index, others may opt for Sensex. The decision generally depends on several factors like sectoral or thematic strategies of the fund house, asset allocation, investment objective etc.

Whereas in the case of the stock market,

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