Indices of share prices:

The stock market index is a very important indicator of the performances of share prices. It takes a set of stocks as representative of the prices of shares in the market, and by tracking the changes in this index, we can get an idea of the overall market sentiment. The stock market index is a pointer to market behaviour. The stock market index reflects market direction and indicates day-to-day fluctuations in stock prices.

What are the characteristics of a good index of share prices? A good index should have two characteristics. First, it should  consider a set or group of scrips that have high market capitalisation, secondly, these scrips should also be highly liquid. Market capitalisation, as we have seen, refers to the sum of the market value of all the stocks included in the index. The market value is obtained by multiplying the price of the shares with the number of shares outstanding. Liquidity refers to the ease with which a share can be bought or sold at a price close to the current market price.

The majority of the stock market indices used in practice falls in two categories:

(i) equal weighted index and (ii) value-weighted index. The former is an index that reflects the simple arithmetic average of the  sample shares at a certain time (year or month or day) with reference to the base period. The latter reflects the aggregate market capitalisation of the sample shares in a certain time with reference to the base time period. Thus what we had earlier referred to as price average can also be viewed as equal weighted index and what we had referred simply to price index can be called value-weighted index.