How Stock Market Index is Calculated and it's Methodology

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Has the numbers or what is known as the stock market index always fascinated you? Do you understand the relevance of the stock market indices to everyday investors? Or, how stock market index is calculated?

In the Indian stock market, there are two exchanges or stock market indices namely, the Sensex and NIFTY. And for each of these indices, the calculation will remain independent and never constant.

Very rarely do even experienced investors and traders know anything about how the index is calculated in the stock market. So it would give beginner-level investors a one-up if they understand the science behind the stock market index.

Stock Market Index Meaning

The meaning of the stock market index is the metric of the stock market that assists investors and traders in the pricing and performance of individual stocks as well as the overall market. Remember, the stock market index is an arithmetic value.

After this basic definition, let us now understand one by one the concepts of the Sensex (Sensitive Index) and Nifty 50 index.

But keep in mind to invest in Stock Market, one must have a basic understanding of key concepts such as the Stock Market Index.

Sensex Meaning

The BSE Sensex index is a list of 30 companies that are chosen based on performance as a measure of free-float market capitalization.

To better understand the procedure of how is Sensex calculated using total free-float market capitalization, take a look at the following Sensex stock market index calculation formula :

Sensex Index Value= (total free-float market capitalization/ Base market capitalization) x Base index value

In the above formula, some terms have been used. We will define each of these terms so that you can comprehend the calculation better.

Free Float: Free float refers to the number of shares of a company that are available for trading.
Market capitalization: This refers to the total worth of a company's stocks in the stock market.
Total Free Float Market Capitalization: The multiplication of the free float factor with market capitalization gives the total free-float market capitalization.
Base Market Capitalisation & Base Index Value: The base year for market capitalization calculation is 1978-79 and the base index value is 100 index points.

So this formula is how the stock market index is calculated for BSE Sensex. Now, we will move towards NIFTY 50.

NIFTY Calculation

To calculate the NIFTY 50 Index through the Free flow market capitalisation method, we need to apply a formula somewhat similar to that of the Sensex. Here’s the formula for how NIFTY is calculated:

NIFTY Index Value = (Current Market Value/Base Market Capital) * 1000

This straightforward formula has a terminology namely the Current Market Value. The current market value is calculated by multiplying the market capitalization of a company with the IWF factor.

Now, what is this IWF?

IWF or Investible Weight Factor is just like the free float factor, which means that it is determined by the portion of shares of a company that are available for trading in the stock market.

So, the higher the IWF factor, the more shares are available for the public investment market.

The above calculation makes the Sensex and NIFTY index seem quite similar, but the fundamental difference is that NIFTY is an index of the top 50 companies, unlike Sensex.

It’s a fact that those who understand the index calculation have a better understanding of how the stock market works.

Conclusion

Now, you know exactly how the stock market index is calculated. Subsequently, this calculation is utilized by BSE and NSE in deciding on the inclusion of the companies into the Sensex and NIFTY index respectively.

These indices indirectly form a basket of stocks on which new investors can reliably invest. To gain more knowledge on such intriguing concepts, keep reading these blogs regularly.