What is the Sensex and the Nifty?
These are the two most popular indices for Indian stock markets and are produced by the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) respectively.
The Sensex which was first calculated in 1986 is based on the market capitalisation (share price times the number of shares outstanding) of 30 important stocks. The actual stocks have changed over the years along with the Indian economy but in general the Sensex represents the stock prices of the largest and most important companies from a variety of sectors. It is updated every 15 seconds during trading hours.
Are there any other indices?
Yes, it is important to understand that the Sensex and the Nifty are just the most popular of many different indices. Both the BSE and the NSE produce several other indices which cover smaller firms and individual sectors.
For example the S&P CNX 500 is a broad-based index which covers 500 firms and therefore gives a broader picture of the stock market as a whole than narrower measures like the Nifty. The BSE-500 is another broad index produced by the BSE. These two indices cover more than 90 per cent of the market capitalisation of all the firms in their respective stock exchanges.
Both exchanges also produce sector-specific indices. For example you have the BSE Auto Index, BSE IT Index, CNX Pharma Index, CNX Bank Index and so on. Both exchanges also have indices which focus on mid-cap and small-cap firms: BSE Mid-Cap, BSE Small-Cap, CNX Midcap etc.
What are the uses of an index?
In addition to their general role as a summary of market conditions, indices are of great use to the financial sector.
They are used to benchmark mutual fund performance; ie to see how a particular fund is performing relative to the broader market.
They are used in creating new financial products called index derivatives (financial products whose value is derived from the level of a particular index).
Also they are used by index funds which invest passively in the stocks of a particular index instead of trading actively.
Look beyond the markets and invest
The bottom line is that the Sensex and Nifty are good starting points but investors need to look beyond them when it comes to understanding market movements.
For example it's possible that when the Sensex is booming, mid-cap firms may be lagging behind.
Or the booming Sensex may be driven by just one particular sector like capital goods while IT may be doing quite poorly. To get a full picture of what's happening, you need to look at a combination of indices.