Index construction methodology

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Marketopedia / Stock Markets Basic / Index construction methodology

The construction of the index is based on a comprehensive methodology, taking into consideration all the relevant factors. We include factors with regard to the range of securities, market capitalisation and sector weighting, among others. The methodology allows us to build an index that provides a diversified representation of the applicable market.

It is essential to be familiar with the construction of an index if one desires to become a successful index trader. As previously discussed, it consists of numerous stocks from distinct categories representing the overall economy. A stock must satisfy specific standards in order to be included in the Index. 

Once it has been accepted as a part of the Index, it must adhere to those criteria for continued eligibility; if not, that particular stock will be replaced by one that fulfills all requirements.

The selection procedure populates a list of stocks with assigned weightage, which defines the amount of importance each stock in the index is given compared to other securities. To illustrate, 3.85% of Nifty’s flux can be accounted for by ITC Limited if it holds a 3.85% weightage in the Nifty 50 index. A complete look at the weights of all index shares is available here.

A key query is – What is the method to assign weights to the shares that form the Index?

The Indian stock exchange assigns weights using the free-float market capitalization method. The larger the company’s market capitalization, the higher importance it is given.

Market capitalization calculated by the free float method is the result of multiplying the number of outstanding shares in the market and the stock price.

For eg. Company ABC has 100 shares outstanding on the market, with a current stock price of 50 each. Consequently, the free-float market cap of ABC comes to Rs.5,000 (100*50).

S. No.Company NameWeightage
1Reliance Industries Limited10.50%
2HDFC Bank Limited9.23%
3ICICI Bank Limited7.81%
4Infosys Limited7.13%
5Housing Development Finance Corporation Limited6.16%

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7ITC Limited4.35%
8Kotak Mahindra Bank Limited3.28%
9Larsen & Toubro Limited3.34%
10Axis Bank2.99%

As of Feb 28, 2023

The Nifty index is most responsive to fluctuations in Reliance Industries Ltd’s price, as it has the highest weight.

Sector-specific indices

The sector-specific indices provide a comprehensive view of the performance of the different sectors within an economy. They measure the movements in stock prices for companies in each sector. Traders, investors, and analysts use this information to understand how each sector is performing, compare returns across sectors, and make informed decisions.

The Sensex and Nifty provide insights into the broad market, whereas sectoral indices show the mood of particular industries. A notable example is the Bank Nifty on NSE, which displays the sentiments in banking. Likewise, CNX IT on NSE indicates how IT stocks perform in the market. BSE and NSE both have dedicated sector-specific indexes that are set up and kept in line with other major indices.