How Sensex is Calculated & How to Invest: A Step-by-Step Guide

The Sensitive Index, or Sensex, is a price-weighted index and is a reflection of the collective market price of 30 of the largest and most actively traded shares on the Bombay Stock Exchange (BSE). The 30 companies that constitute the Sensex are selected based on various criteria such as market capitalization, liquidity, revenue, and sector representation. The diversity of industries represented in the 30 companies makes Sensex a well-diversified index.

How is the Sensex calculated?

Calculation of Market Capitalization: The market capitalization of each index company is calculated by multiplying its share price with the total number of outstanding shares of the company.

Free-Float Factor: Only those shares that are freely tradable are considered. Shares held by promoters, government holdings, and other restricted shares will be excluded.

Base Year & Base Value: The index is considered to have as its base year 1978-79 with a base value of 100. Any current value is determined by taking that base into account; thus, the value of the Sensex is calculated through an indexing formula depending on the total market capitalization compared to the base year's market capitalization.

The formula of the Sensex is:

Sensex = (Total Free-Float Market Capitalization / Base Market Capitalization) × Base Index Value

Thus, it increases when most of the stocks are going up in the index and vice versa.

Investing in the Sensex: A Step-by-Step Guide

Investing in the Sensex is easy for the common man; there are multiple options, such as an individual purchase of an equity stock, investment in index funds, or ETFs trading. Here is the step-wise guide:

Step 1: Open a Demat and Trading Account

To purchase shares or mutual funds based on Sensex, a person needs to have a Demat account and a trading account under a registered brokerage. Several platforms provide seamless online account setup, thus with KYC verification.

Step 2: Choose Your Investment Method

There are several ways to invest in the Sensex:

Direct stock investment: Buying shares of the 30 Sensex companies directly.

Index Funds-—investment in a mutual fund that copies the Sensex portfolio.

Exchange-traded funds (ETFs): Trade in Sensex-based ETFs just like trading in common stocks.

Derivatives trading: Trading products such as options and futures contracts for speculative or hedging strategies in the Sensex.

Step 3: Analyze Market Trends & Volatility

Research the market tendencies, the basics of the companies, and macroeconomic trends before actually entering the market. This can be done through the past performances of the Sensex, India VIX levels, and the global markets available for the decision.

Step 4: Decide on Lump-Sum or SIP Investment

Lump sum investment. Investment is done with a large amount in a single transaction.

SIP a fixed amount at regular intervals in index investment with risk diversification through rupee cost averaging.

Step 5: Executing the Investment

If individual stocks are invested in, this trading platform will be used to buy into the Sensex-listed companies.

However, if a person is investing in mutual funds or ETFs, after selecting the fund they want to invest in, they execute the buy order through their brokerage.

Step 6: Monitor & Rebalance the Portfolio

Monitoring and keeping up on investments periodically would lead to reviewing the performances involved.

Change the resulting portfolio in line with the economic changes expected, trend in the market, and investment goals.

Investment Risks and Rewards in Sensex Investments 

Diversification: Investing in Sensex gives one an exposure to all those sectors where the top-performing companies reside.

Long-Term Growth: Historical data suggest that in the long run, Sensex has yielded strong returns.

Liquidity: Shares and ETFs attached to the Sensex are very liquid, which makes it easier for buy and sell transactions. Risks:

It may be short-term. Changes in the economy often reflect on the index at the Sensex.

It may be time-specified with the economics. This may be inflation and interest rates or whether the world is doing better or worse in terms of economy.

Company-Specific Threats: This index is prone to being affected negatively due to poor performance in any of the 30 companies.

Conclusion

Investing in the Sensex is a fortuitous way of participating in the economic growth of India. Gaining insights into the calculation of Sensex and its application as a risk indicator through India VIX will be greatly helpful in making sound investment decisions. Whether through direct stock, index funds, or ETFs, a well-planned approach can lead to financial success.