Index construction methodology

 It is important to know how the index is constructed /calculated especially if one wants to advance as an index trader. As we discussed, the Index is a composition of many stocks from different

sectors which collectively represents the state of the economy. To include a stock in the index

it should qualify certain criteria. Once qualified as an index stock, it should continue to qualify on

the stated criteria. If it fails to maintain the criteria, the stock gets replaced by another stock

which qualifies the prerequisites.

Based on the selection procedure the list of stocks is populated. Each stock in the index should

be assigned a certain weightage. Weightage in simpler terms define how much importance a certain stock in the index gets compared to the others. For example if ITC Limited has 7.6% weightage

on Nifty 50 index, then it is as good as saying the that the 7.6% of Nifty’s movement can be attributed to ITC.

The obvious question is - How do we assign weights to the stock that make up the Index?

There are many ways to assign weights but the Indian stock exchange follows a method called

free float market capitalization. The weights are assigned based on the free float market capitalization of the company, larger the market capitalization, higher the weight.

Free float market capitalization is the product of total number of shares outstanding in the market, and the price of the stock.

For example company ABC has a total of 100 shares outstanding in the market, and the stock

price is at 50 then the free float market cap of ABC is 100*50 = Rs.5,000.

At the time of writing this chapter, the following as per Table 7.1 are the 50 stocks in Nifty as per

their weightage…