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What is the Share Market Index?

July 2018

By WM in the Classroom

July 14, 2018 | Dubai

Just like a thermometer is used to determine the temperature or a weighing scale the weight of an individual, the index becomes a barometer for the performance of a particular market. For example, the Bombay Stock Exchange, India has over 5500 listed securities – however, its performance gets represented by only 30, which make up the BSE Sensex (Sensitivity Index).   Stocks selected within the index act as representatives presenting a diversified view of the market as a whole. See more on the DFM General Index and BSE Sensex composition here.

So what makes a company eligible to act as a representative to its sector and form part of the index? While there’s no standard rule to the same, the criteria listed in regards to the DFM General Index does present an idea

  • The total trade value of the company shares shouldn’t be less than 1% of the total trade value of DFM during the evaluation period (six months), or 10% of the company’s market capitalization (Velocity) at the end of the evaluation period.
  • The company shares should be traded on 50% of the total trade days throughout the evaluation period.
  • Total number of transactions on the company shares should not be less than 150 transactions.
  • The trade volume should not be less than 500,000 shares throughout the evaluation period.
  • The total trade value shouldn’t be less than AED 100 million throughout the evaluation period.

(Source: DFM General Index “DFMGI” Rules – January 2016)

From the above, it is evident that some of the qualities essential for inclusion with the index are

  • Size of the company
  • Trading frequency
  • Trading depth & volume
  • Liquidity

How is the index calculated? Let’s assume we want to create a Healthcare index and we have decided to set a base value for the same at 1000.

Step 1: Identify stocks: Based on the parameters listed above, we have identified 3 stocks within this sector from the overall base of 14 companies: ABC Hospitals, DEF Pharmacy and XYZ Medical Equipment. What we have used as parameters are market capitalization and diversification.

Step 2: Use the free float shares & market price as shown in the table below

Table 1

Step 3: Using our assumed base value of 1000, we determine the current level of the index today = (850,000/ 830,000) x 1,000 = 1024 points, implying that there has been a 2.4% jump in the Healthcare index today.

Thus, while the price of a security is said to be representative of the fundamentals of the company, emerging from the demand-supply dynamics, the index translates all of the complex happenings across the market in a numerical value, acting as an indicator. It enables comparison including performance measurement and benchmarking.

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