What do index in stock markets imply and its significance?

Typically, index in stock markets captures the state of the overall equity market. Price of the company stock in the secondary market varies in relation to fundamentals of the company i.e. growth recorded by the company, new product launch or such other factors and country-specific factors such as announcement of the budget, monetary policy review by the concerned authorities etc.

So, index works to factor-in or take into account variations in the stock market as a whole including country-specific factors. The job is done through the process of averaging. Each of the stock includes two elements, stock-specific news and index news. And a good index value would cancel out stock-specific news and instead take into account news common to all the given set of stocks i.e. country-specific news.

Ups and downs in index value

The upward and downward movement of stock market index is indicative of the change in stock market expectations with regard to future dividends of the corporate sector in India. The surge or upside in the index value suggests that the stock market is optimistic about the future dividends of the corporates than before. On the other hand, fall or downside in the index implies that the stock market holds negative outlook with respect to the future dividends of the corporates. Ideal index shows real-time reading that reflects future outlook of the Indian corporates as perceived by the stock markets.

Significance of indices

Historically, indices have been looked upon as information source. Index value highlights the performance of the market. Of, late indices have found greater relevance in the field of finance on account of introduction of index derivatives and index funds. Index funds are primarily funds that invest passively in the index while index derivatives enable traders to hedge their risk exposure to an index and also speculate in respect of future index movements.

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