Friday, February 22, 2013

Excellent Trading School - 10 - Index

A market index for example consists of a group of top stocks traded in the market and its value changes as the prices of its constituent stocks change. In India, Nifty Index is the most popular stock index and it is based on the top 50 stocks traded in the market. Just as derivatives on stocks are called stock derivatives, derivatives on indices such as Nifty are called index derivatives.

Understanding the Stock Index

An index is a number, which measures the change in a set of values over a period of time.

A stock index represents the change in value of a set of stocks, which constitute the index. A stock market index is created by selecting a group of stocks that are representative of the entire market or a specified sector or segment of the market. It is calculated with reference to a base period and a base index value.

Stock market indices are meant to capture the overall behavior of equity markets.

Index movements reflect the changing expectations of the stock market about future dividends of the corporate sector.

The index goes up if the stock market perceives that the prospective dividends in the future will be better than previously thought. If the prospects of dividends in the future become pessimistic, the index drops.

Index derivatives: Index derivatives are derivative contracts, which have the index as the underlying. The most Popular index derivative contracts the world over is index futures and index options. NSE’s Market index, the S&P CNX Nifty was scientifically designed to enable the launch of index based Products like index derivatives and index funds.

Stock index is difficult to manipulate as compared to individual stock prices. This is partly because an individual stock has a limited supply, which can be manipulated.

Index derivatives are cash settled, and hence do not suffer from settlement delays and problems related to bad delivery, forged/fake certificates.

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