Are you wondering, what is Sensex and how is it calculated? – If yes then it indicates that you clearly have no idea what a Sensex is. Also, you are a newbie who just entered in the stock market. It is not just the entry-level investors or traders who aren’t aware of this but many experienced investors aren’t familiar with the methodology employed to calculate the Sensex.
In this article, we will discuss the Sensex and calculation methodology for Sensex.
So, what is Sensex…?
Well, in short, it is a benchmark index of the country linked to the Bombay Stock Exchange (BSE). Sensex is also called BSE-Sensex, issued in the year 1986 however the exchange itself established in the year 1875. The Sensex index is based on the financial performance of 30 reputable, large-cap, and liquid companies. It is these 30 stocks that decide the general direction of rest of the stocks listed on the BSE.
How is Sensex Calculated?
It is the BSE that pioneered the stock trading activity in the country. During its journey of over a century, the Indian capital market has been through both good and bad times. Initially, the index was calculated based on the “Full Market Capitalization” methodology but on September 1, 2003, the calculation methodology moved to the “Free-float Market Capitalization”.
Free-float market capitalization is defined as that proportion of the total no. of shares by the company that is readily available for trading in the market. And all promoters’ holdings, government holdings, and another strategic holding won’t be included in the calculation of it, only the no. of shares that are available for trading to the general public.
To get a better understanding, let’s take an example:
Let’s assume there is a Company named XYZ which has 1000 shares in total. Out of this, 400 are held for promoters and rest 600 is available for the general public for trading. These 600 shares are called “free-floating shares”.
Suppose the price of each share is Rs. 100.
The total market capitalization = 1000 shares * Rs. 100 = Rs. 200,000
Free-float market capitalization = 600 shares * Rs. 100 = Rs. 60,000
Now let’s jump to the calculation of the BSE-Sensex index.
Calculation Methodology of BSE-Sensex
In order to do the calculation of Sensex index let’s suppose the index consists of only 3 stocks i.e. Stock A, Stock B, and Stock C etc.
So, the total free float market capitalization (of A & B) = Rs. 1,00,000 + 3,00,000 + 6,00,000 = Rs. 10,00,000.
The thing you need to remember here is that during 1978-79 – the base year of the index with a value set to 100. If we believe that the total market capitalization of the stock was said to 12,000.
The value of index will be:
INDEX = Base * (Current market capitalization/ Base market capitalization)
= 10,00,000 * (100/12000) = 8,334 approx.
So, the value of the index is 8334 approx. And 100/12000 here is index divisor.
Hope, this article helped you in understanding the calculation methodology of the BSE-Sensex index. Nevertheless, if you have any query or would like to add something then doesn’t forget to mention in the comment section below.