The method adopted for calculating Sensex is the free- float market capitalization weighted method in which weights are assigned according to the size of the company. Larger the size, higher the weightage. The base year of Sensex is 1978-79 and the se index value is set to 100 for that period. WHY IS THE BASE VALUE SET TO 100 POINTS?
The total value of shares in the market at the time of index construction is assumed to be ’100′ in terms of ‘points’. This is for the purpose of ease of calculation and to logically represent the change in terms of percentage. So, next day, if the market capitalization moves up 10%, the index also moves 10% to 110. HOW ARE THE STOCKS SELECTED?
The stocks are selected based on a lot of qualitative and quantitative criteria. You can view the listing criteria here. HOW IS THE INDEX CONSTRUCTED?
The construction technique of index is quite easy to understand if we assume that there is only one stock in the market. In that case, the base value is set to 100 and let’s assumes that the stock is currently trading at 200. Tomorrow the price hits 260 (30% increase in price) so, the index will move from 100 to 130 to indicate that 30% growth. Now let’s assume that on day 3, the stock finishes at 208. That’s a 20% fall from 260. So, to indicate that fall, the Sensex will be corrected from 130 to 104(20%fall). As our second step to understand the index calculation, let us try to extend the same logic to two stocks – A and B. A is trading at 200 and let’s assume that the second stock ‘B’ is trading at 150. Since the Sensex follows the market capitalization weighted method, we have to find the market capitalization (or size of the company- in terms of price) of the...