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Monday, January 9, 2017

How To Create Your Own Stock Market Index [With Real Life Example]

Have you ever wondered whether it possible to create your own Stock Market Index like the Sensex or the Nifty? 

The Answer is yes and today, as a fun activity, I will teach you how you can Create your very own Stock Market Index.  


How To Create Your Own Stock Market Index [With Real Life Example]

However, before we start, let us understand what a Stock Market Index is. 

What is a Stock Market Index? 


A Stock Market Index is an indicator of Market Momentum or Sentiment. An Index is created by selecting stocks that are representative of the entire market or a specific sector of the market.


It indicates the market movement by tracking the changes in Market Capitalisation of Stocks that represent the Index. A company's Market Capitalisation is arrived at by multiplying the total outstanding shares of a company by its current market price. 


For a more detailed understanding of Stock Market Indices, refer to the following post: 

What Is A Stock Market Index and What Does It Represent 


Here are a Few Quick Facts about a Stock Market Index. 


>> A Stock Market is created by selecting stocks that either represent the entire market or a specific sector of the market. 


>> A weightage is assigned to each individual stock that comprise the Index. 


>> A Stock Market Index tracks the changes in Market Capitalization of the stocks it represents. 


>> The Market Capitalisation is Free-Float Market Capitalisation. Free-float market capitalization takes into consideration only those shares issued by the company that are readily available for trading in the market. It excludes locked in shares like government holding or shares locked in under a contract. 


>> The Index tracks the Market Capitalization with respect to a base date. 


>> A score is assigned to the Base Date Market Capitalization of the stocks that represent the Index. This score can be 100 or any other number. 


>> Daily changes in Market Capitalization is tracked with reference to this Base Date Score. 


Now that we have a basic understanding of a Market Index, let us proceed to create our very own Stock Market Index. 


We will create our Stock Market Index in the following steps: 


>> Naming our Index. 


>> Selecting Stocks that will represent our Index. 


>> Determining the weightage of each individual stock in the Index. 


>> Selecting a Base Date. 


>> Determining the Base Date Market Capitalization of the stocks that represent the Index. 


>> Assigning a Score to this Base Date Market Cap. 


>> Tracking daily changes in Market Cap of the constituent stocks with reference to this Base Date Score. 


Let us now follow each of these steps to create our own Market Index.


Naming our Index. 


We start by assigning a name to our Index. I will call my Index the "FINMINT FOCUS 5". You can select your own name for your Index - just be as creative as possible.  


Selecting Stocks that will represent our Index. 


The next step is to select stocks that will represent our Index. I wish to model "FINMINT FOCUS 5" as a broad market Index, so I will select 5 different stocks from 5 sectors of the economy. 


A Broad Market Index represents the different sectors of the economy as a whole.  


The following are the stocks that I have selected along with the industries that they represent. 


1. State Bank Of India [ Financial Services - Bank].

2. Sun Pharmaceutical Industries Ltd. [ Pharma]. 
3. Tata Motors Ltd [Automobile]. 
4. Larsen & Toubro Ltd. [Construction]. 
5. NTPC Ltd. [Energy]. 

Note that you can select any number of stock for your Index.  


Determining the weightage of each individual stock in the Index. 


For "FINMINT FOCUS 5" I will assign an equal weightage to all the 5 stocks that comprise the Index.


Selecting a Base Date. 


Next we will proceed to select a Base Date for our Index. "FINMINT FOCUS 5" will have a Base Date of 6th January, 2017


Determining the Base Date Market Capitalization of the stocks that represent the Index. 


The Base Date Closing Price and Market Cap of the 5 selected stocks are as follows: 


 1. State Bank Of India [ Closing Price - 246.05, Market Cap - 76,354.67 cr ].

2. Sun Pharmaceutical Industries Ltd. [ Closing Price - 641, Market Cap - 69,395.74 cr ]. 
3. Tata Motors Ltd [ Closing Price - 498.55, Market Cap - 96,286.07 cr ].
4. Larsen & Toubro Ltd. [ Closing Price - 1390.20, Market Cap - 114,098.93 cr ].
5. NTPC Ltd. [ Closing Price - 163.70, Market Cap - 40,567.68 cr ]

The Total Market Cap of the 5 stocks is: 396,703.09 cr


Assigning a Score to this Base Date Market Cap. 


The Total Market Cap of "FINMINT FOCUS 5" on the base date of 6th Jan, 2017 is 396,703.09 cr. We assign a Base Date score of 100 to this value. 


Thus, the value of our Index as on 6th Jan 2017 is 100 Points


Tracking daily changes in Market Cap of the constituent stocks with reference to this Base Date Score.


Next we will track the changes in the value of our Index on the next trading day with reference to the changes in Market Cap of the 5 constituent stocks. 

The Closing Price and Market Cap of the 5 selected stocks as on 09.01.2017 are as follows: 

1. State Bank Of India [ Closing Price - 246.70, Market Cap -  76,711.76 cr ].
2. Sun Pharmaceutical Industries Ltd. [ Closing Price - 632.10, Market Cap -  68,453.50 cr ]. 
3. Tata Motors Ltd [ Closing Price - 501.25, Market Cap -  96,750.34 cr ].
4. Larsen & Toubro Ltd. [ Closing Price - 1,379.00, Market Cap -  1,13,254.03 cr ].
5. NTPC Ltd. [ Closing Price - 163.35, Market Cap -  40,332.69 cr ]

Thus, the Total Market Cap of the 5 stocks as on 09.01.2017 is: 395,502.30 cr

We proceed to determine the Value of our Index as on 09.01.2017 with the help of some simple arithmetic. 

Value of Index on 09.01.2017 = Current Market Cap / Base Market Cap * Base Index Value (100)

= 395,502.30 / 396,703.09 * 100
= 99.70 Points

Thus, the value of our Index, "FINMINT FOCUS 5" on 09.01.2017 is 99.70 Points

This represents a change of 0.30 points or 0.30 % from our base date. You can compute the value of your Index on any given day in a similar manner. 

Hope you have like this little presentation of our's. Thanks for your time and happy experimenting! 

Source Data for Stock Prices and Market Cap: NSE

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