Nifty and Sensex explained, in plain words

What is a stock market index?

A stock market index is a single number that tracks the combined price movement of a chosen group of shares. It tells you, at a glance, whether that group as a whole went up or down.

Thousands of companies are listed in India. Nobody can watch all of their prices every minute. An index solves this by picking a group of companies, following their prices, and turning them into one number that rises when the group rises and falls when the group falls.

Think of a class of 40 students. Instead of reading 40 report cards, a teacher can look at the class average to see whether the class did better or worse than last term. An index is a little like that average, with one important difference: bigger companies count for more. We will see why below.

The number itself has no meaning in rupees. An index level is compared only with its own earlier levels. A rise from one day to the next tells you the group gained value. The size of the number does not. If shares and exchanges are new to you, start with stock market basics for beginners.

What are the Nifty 50 and the Sensex?

The Nifty 50 tracks 50 large companies listed on the National Stock Exchange (NSE). The Sensex tracks 30 large companies listed on BSE. Both are India's most quoted market indices.

The companies in each index are chosen by fixed rules, mainly about size and how much the shares are traded. The list is reviewed regularly, so a company can be added or removed. Many large companies appear in both indices, because many large companies are listed on both exchanges.

Both are updated live through the normal trading session, which runs from 9:15 to 15:30 IST on trading days.

What does free-float market capitalisation mean?

Market capitalisation is a company's share price multiplied by its number of shares. Free-float market capitalisation counts only the shares that are actually available for the public to trade.

Start with market capitalisation, often called market cap. If ABC Limited, our made-up mobile company, has 10 crore shares and the price is Rs 100, its market cap is 10 crore times Rs 100 = Rs 1,000 crore. That is what the whole company is worth at today's price.

But not every share is available to buy. Founders, the promoter group or the government may hold a large part and rarely sell it. These shares are "locked" in practice. The shares left over, which ordinary investors can buy and sell, are the free float.

If ABC's promoters hold half of its shares, only 5 crore shares are free float. The free-float market cap is then 5 crore times Rs 100 = Rs 500 crore.

Both the Nifty 50 and the Sensex use free-float market cap to decide how much each company counts. This means a company whose shares are mostly held by insiders gets a smaller weight than its full size would suggest. The aim is that the index reflects what investors can really trade.

A worked mini index with three made-up companies

Here is a tiny index of three made-up companies. It shows that a weighted index moves by each company's change multiplied by its weight, so a big company's move counts for more than a small company's move.

All the companies and numbers are invented. We call our index the "Mini 3" and start it at 1,000 points on day one, a made-up starting number.

Day one: work out each company's free-float market cap.

For example, ABC: 10 crore shares times 50 percent = 5 crore free-float shares, times Rs 100 = Rs 500 crore. Its weight is 500 / 2,000 = 25 percent.

Day two: prices move. ABC rises 10 percent to Rs 110. XYZ Foods falls 5 percent to Rs 190. PQR Motors stays at Rs 50.

• ABC: 5 crore free-float shares times Rs 110 = Rs 550 crore.
• XYZ Foods: 4 crore free-float shares times Rs 190 = Rs 760 crore.
• PQR Motors: 14 crore free-float shares times Rs 50 = Rs 700 crore.
• New total: 550 + 760 + 700 = Rs 2,010 crore.

The new index level is 1,000 times 2,010 / 2,000 = 1,005. The Mini 3 rose 0.5 percent.

Check it with weights. ABC's 10 percent rise times its 25 percent weight adds 2.5 percent. XYZ's 5 percent fall times its 40 percent weight takes away 2.0 percent. PQR adds nothing. 2.5 minus 2.0 = 0.5 percent. Same answer.

Why not a simple average of prices? On day one the average price is (100 + 200 + 50) / 3 = Rs 116.67. On day two it is (110 + 190 + 50) / 3 = Rs 116.67. A simple average says nothing happened, even though investors in total gained Rs 10 crore of free-float value. Weighting fixes this.

Real indices follow the same idea with more companies, plus adjustments so that events like share splits or a company being replaced do not make the index jump by themselves.

Why is an index not a share?

An index is a measurement, not a thing you can own. You cannot buy "one Nifty" or "one Sensex" the way you buy one share of a company. You can only buy products that are designed to follow an index.

A thermometer shows the temperature, but you cannot own the temperature. An index is like that thermometer for a group of shares. It has no profits, no shareholders and no dividends of its own. It is just a number worked out from the prices of the companies in it.

This matters for two reasons. First, when the index rises, it does not mean every company in it rose. In our Mini 3, the index went up while XYZ Foods went down. Second, an index level is not a price in rupees. A higher index number does not make the index "costlier" or "cheaper" to buy, because you cannot buy it directly.

When people say they "invest in the Nifty", they usually mean they hold an index fund or an exchange traded fund that tracks the Nifty 50. Those are explained next.

What are index funds and ETFs?

An index fund is a mutual fund that holds the shares of an index in roughly the same weights, so its value tends to follow the index. An exchange traded fund (ETF) does the same, but its units trade on the stock exchange like shares.

Here is the plain difference between the two:

• Index fund. You buy and sell units with the fund house, usually once a day at that day's net asset value (NAV). NAV is the value of one unit, worked out from the fund's holdings. You do not need a demat account for most mutual funds.
• ETF. You buy and sell units through a stockbroker during market hours, at the price on the exchange. You need a trading and demat account, explained in demat account explained.

Both have costs. Funds charge a yearly fee called the expense ratio, and ETFs also involve brokerage and other charges when you trade. Neither will match the index exactly. The small gap between a fund's return and its index's return is called tracking error.

An index fund or ETF goes down when its index goes down. Holding many companies spreads the risk of any one company, but it does not remove market risk. Losses are possible, and past movement of any index tells you nothing certain about the future. We do not recommend any fund.

Common mix-ups

These are the things beginners most often confuse about the Nifty and the Sensex, each with a correction.

1. "The Sensex is higher than the Nifty, so BSE is bigger." No. The two indices started at different base numbers in different years. Their levels cannot be compared with each other. Only their percentage changes can.
2. "The market rose, so my shares rose." Not necessarily. An index is a weighted summary. Many shares can fall on a day the index rises, as XYZ Foods did in our example.
3. "Every company counts equally in the index." No. Weights depend on free-float market cap, so a few large companies can move the index more than many small ones.
4. "The Nifty includes the 50 biggest companies by any measure." Not exactly. Selection follows the index rules, which look at free-float size, trading activity and other conditions, and the list is reviewed regularly.
5. "A falling index means the economy is in trouble." Not always. Indices react to expectations and mood as well as facts, as explained in why share prices change.

Check yourself

Try these three questions using the Mini 3 index. The answers follow each question.

1. A company has 4 crore shares, a price of Rs 300 and a free float of 50 percent. What is its free-float market cap?
   Answer: 4 crore times 50 percent = 2 crore shares. 2 crore times Rs 300 = Rs 600 crore.
2. In the Mini 3, PQR Motors (weight 35 percent) rises 10 percent and the other two do not move. Roughly how much does the index move?
   Answer: 10 percent times 35 percent = 3.5 percent. The index rises from 1,000 to about 1,035.
3. Can you buy one unit of the Sensex itself?
   Answer: No. The Sensex is a measurement. You can only buy products, such as index funds or ETFs, that are built to follow it.

Where to check this yourself

The exchanges publish their index lists, rules and live values on their own websites. Use them, not social media posts, as your source.

• National Stock Exchange (NSE): the Nifty 50 and its current list of companies.
• BSE: the Sensex and its current list of companies.
• SEBI investor website: free guides on mutual funds, ETFs and investor protection.
• SEBI: rules for mutual funds and the market as a whole.

For the words used on this page, see the stock market terms glossary.