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How do the points in Sensex increase or decrease and based on what?

During the 1850s, 4 Gujarati and 1 Parsi stock broker used to gather under a banyan tree in front of Mumbai’s town hall for trading. The number of brokers grew over the years and they eventually moved to a new location Dalal street in 1875. 318 members joined this group by paying 1 Rupee each We call it the ‘Bombay Stock Exchange’ (BSE) today.
               


     In 1986 BSE came up with SENSEX (SENSitive indEX) to measure the performance of stock markets. Before this, there was no precise scale to measure highs and lows of Indian stock market. Initially, Sensex was calculated based on a method called Full Market Capitalization. From 2003 onwards, Free Float Market Capitalization method is being used. 

   I will try to explain what these methods are and how Sensex is calculated with the following example:

Say there are only 2 companies in the market- X & Y. 

X has 250 shares out of which 200 are available for general public (called free floating shares) and 50 are owned by company management. Each share is valued at Rs 200.

 Now the total company value is = total no of shares * each share value = 250*200 = Rs 50,000.

This is called total market capitalisation of X.

Free float market capitalisationof X= Free floating shares* share value = 200*200 = Rs 40,000  

For company Y, say free floating shares are 150 and free float market capitalisation is Rs 60,000. 

Now the free float capitalisation of entire market adds up to 1 lakh rupees (sum of X&Y). 

We’re just one step away from calculating Sensex. Before doing that we need to know about one small thing - Base Index.

Assume we’ve been indexing(calculating Sensex) this market (comprising of stocks X & Y) from past 10 years. On the first day of indexing, we found out that market value is Rs.10,000. We said that this amount of ten thousand is equivalent to 100 Sensex points. This is called Base Index (On the very first day BSE started indexing, Sensex was 100. Base index was made 100 just for ease of calculations.)

Now come back to calculating today’s Sensex. So market share is 1 lakh. If 10,000 is equivalent to 100 Sensex points then 1 Lakh is equivalent to 1000 Sensex points. 

Next Day scenario- Company X is doing better and each of its shares is more by Rs 50. Now free float market capitalisation is Rs 110000. So Sensex is 1100 points.

An increase in Sensex indicates that the overall economy of country is good and investors have faith in the growth story of the market. A decrease in Sensex over period indicates that all is not good for the economy. 

Unlike our sample market which has only 2 stocks, BSE deals with 30 stocks and NIFTY with 50. Usually BSE is higher than NIFTY (27,887 and 8395 points respectively while writing this answer) because BSE deals with market giants which have higher market capitalisation.

30 Sensex stocks: ACC, Ambuja Cements, Bajaj Auto, BHEL, Bharti Airtel, Cipla, DLF, Grasim Industries, HDFC, HDFC Bank, Hindalco Industries, Hindustan Lever, ICICI Bank, Infosys, ITC, Larsen & Toubro, Mahindra & Mahindra, Maruti Udyog, NTPC, ONGC, Ranbaxy Laboratories, Reliance Communications, Reliance Energy, Reliance Industries, Satyam Computer Services, State Bank of India, Tata Consultancy Services, Tata Motors, Tata Steel, and Wipro.

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