4.8 Price Trends Or Index
Index is the average of the prices of shares traded in a stock exchange at a given point of time. Let us take the example of a vegetable market to understand index. When we go to a big organised vegetable market we do say prices of vegetables and fruits are stable or have come down or have gone up? On what basis do we say that? It is based on the prices of important vegetables like onions, tomatoes, potatoes, and carrots etc, right? Even though there are several varieties of fruits and vegetables available in the market for trading, some items like onions, tomatoes, potatoes, bananas etc would dominate the traded value (price multiplied by quantity) in the market. So to avoid any confusion in price trends, if we take the average of all the important (top 10 or 20 traded based on value) vegetable prices, it becomes an index for the vegetables market, which helps us in understanding the price trend in the vegetables market.
In the same manner, in the stock exchanges, though stocks of thousands of companies are listed, stocks of all the companies are not traded in a day and within a day. Though several hundreds of stocks are traded only a few dominate the whole trade in terms of value (price multiplied by number of shares). The ideal index gives us instant-to-instant readings about how the stock market perceives the future of India’s corporate sector.
The advantages of an index are:
- An index reflects market behavior. It shows what the direction of the market is and how sensitive it is to a given set of influencing factors. For example, on January 7, 2009, when the Satyam scam came to light, the Sensex dropped 750 points reflecting the overall market sentiments.
- An index is a benchmark to evaluate any investment in stocks. It is more important for mutual funds and insurance companies who professionally manage your money to provide maximum returns.