What is Sensex? How it is calculated? How is the effect of each share on Sensex calculated?
If you are a complete newbie to Stock Market and just want to know in Layman term what is Sensex and Nifty and do not want to know the every detail of it then just read the next paragraph and skip the next part. If you want to know each and every detail about how Sensex is calculated then continue to the end.
Sensex is basically a Sensitive Index which senses the Indian Stock Market and tells us in which direction the Market is heading. Same is with Nifty. Sensex uses 30 companies to determine its value and Nifty uses 50 companies to determine its value. So if someone says Sensex is up by X points then it simply mean that Indian Stock Market is moving in the positive direction. This does not mean that each and every company in the Stock Market is performing well. Sensex indicates the average of the performances of the 30 companies. So if you add all the absolute changes in the stock prices of these 30 companies, that will result in the final change in the Sensex.
In order to understand the latter part of the answer, first let us clear the two terms namely market capitalization and free float market capitalization.
Market capitalization is equal to (current market price of the stock) * (total number of shares issued by the company)That is, the shares held by Financial Institutional Investors(FII), Promoter group of the company, Government of the country and lastly the retail investors are all considered while calculating market capitalization.
Free float market capitalization is equal to (current market price of the stock) * (total number of shares available for public for trading). The shares held by Financial Institutional Investors(FII), Promoter group of the company and the government of the country have a lock-in period and they cannot be traded directly in the stock market. So in free float market capitalization, only those shares who do not have any lock-in period and are freely available for trading are taken into consideration.
As less number of shares are used while calculating free float market capitalization , free float market capitalization is always less than the market capitalization of any company.
Now, the question comes of how 30 companies are chosen to be a part of Sensex. There are various factors which are as follows:
Listed history – The company should have a listing history of at least 3 months at BSE, preferably more than one year.
Trading frequency – The company’s stock should be traded on each and every trading day for the 3 months reference period.
Market Capitalization - The weight of each stock in SENSEX based on three-month average free-float market capitalization should be at least 0.5% of the Index. (i.e For a company to be a part of Sensex, its free-float market capitalization should be at least 0.5% of the combined free float market capitalization of the 30 companies. When a company does not satisfy this criterion, it is excluded from Sensex)
Revenue. The company must have reported revenue in the last four quarters from core activities.
Track Record: In the opinion of the BSE Index Committee, the company should have an acceptable track record.