Are Indices True Indicators of Market Condition?

Are Indices true indicators of market condition?

A stock market index measures a section of the stock market, in order to act as an indicator of the market, showing whether the majority of the stocks traded in that market are going up or down, thereby also indicating the overall mood of the investors. The SENSEX and Nifty are such indices.

The BSE Index- SENSEX or the Bombay Stock Exchange Sensitive Index is India's first stock market index. Launched in 1986, it is an index of 30 stocks representing 12 major sectors and is tracked worldwide, enjoying an iconic stature. The SENSEX is constructed on a "free-float" methodology, and is sensitive to market conditions. It is a broad-base index as it represents the performance of the entire stock market, and therefore reflects investor and market perceptions and realities.

Like the SENSEX, the National Stock Exchange (NSE)'s Nifty is a well diversified 50 stock index accounting for 23 sectors of the economy and depict the investor and trader sentiments in NSE.

The Stock Market Indices serve varied purposes starting from economic research to helping investors decide upon an appropriate portfolio for their investments. As said earlier, since the Index is an indicator of the overall mood of the investors in the secondary market, it also helps a company answer questions like is it the right time to take out an IPO, how to price the issue, etc. It acts as a signal to the government of the 'feel good' factor prevailing in the economy. It reacts to all important news and events happening in the country. It also reacts to introduction of budgets and this reaction gives an idea of how the budget is accepted by the people and the market.

Like this, it has still many more uses, but the stock market index is a double edged sword. Because it is influenced by expectations of the future performance of the stocks, it leads to a self fulfilling prophecy. Suppose an investor thinks that the stock of the company is going to go down and this feeling prevails across the market then everyone would want to get out of the company's stock. This will automatically lead to the stock prices crashing. This is a case of a single company's stock, but what if a bearish feeling prevails? Then all stock prices will face tough times affecting the index. So just as the market index influences and affects decisions of individual traders, conversely the index itself is also affected by not just the market conditions as it is supposed to but also these players.