When someone asks: How is the Indian stock market doing? People typically get a response like 'Nifty went up by ...' or 'Nifty fell by...'. It actually means that the Nifty 50 index is up or down, which indicates how the top 50 stocks of the country are doing at the moment.
So, first let's understand 2 terms: Nifty50 and index.
Say, there is a very interesting school in your town which only teaches students of Class 10. Just like we had multiple divisions in each class (10th A, 10th B, and so on), this particular Class 10 has 11 divisions. Students are divided into each division based on the famous and relevant subjects of their choice.
Now imagine there is a rich donor called Harshad Mehta who wants to invest money in just one school out of 10.
Though he finds this one to be the most interesting, he wants to confirm this. Since he cannot talk to all students, he decides to talk to the best 50 students in this school. The school selects 5 students from each of the 10 divisions (so 50 in total), since each division represents an important subject and all 50 together can now represent the entire school.
There you go. Now you know what Nifty 50 is.
In the entire Indian stock market, there are about 5,600 listed companies. These companies fall into about 13-15 categories like pharma sector, steel, oil and gas, agro products, banks, insurance etc. When an investor wants to know how the Indian stock market is doing, he obviously cannot check how all 5,600 companies are doing. So he checks the best stocks from all essential sectors of the country to get a first glimpse of how the country is doing on average. These best top Indian stocks together are called Nifty 50 or Sensex. Since there are 2 stock exchanges in India, the top 50 listed on the National Stock Exchange (NSE) are called Nifty 50 while the top 30 on the Bombay Stock Exchange (BSE) are called Sensex.
Who decides which companies will be a part of the top 50? The top 50 companies which have the largest free-float market capitalisation (which is the number of shares that are available for the public to trade in) make their way into the basket of Nifty 50. Nifty 50 gets updated twice a year since many other indexes (like Nifty Next 50 index) depend on Nifty 50.
So how does it affect the stock market? You might have noticed how so many people are obsessed with tracking the Nifty 50 and Sensex. Well, the Nifty and the Sensex indicate India's economic health and public sentiment.
So when they do well (or are in green), it's an indicator to the investors that the rest of the stocks in the country are generally doing well. It also shows that investments in the country are going to get better returns since the country's economic health is good. The vice versa is also true. When the returns are good, investors are more willing to bet on the country's stocks.
So, what's an index? Just like India has 2 indexes called Nifty 50 and Sensex, Japan's stock index is called the Nikkei index. US has multiple stock indexes called Dow Jones Industrial Average, Nasdaq Composites and S&P 500.
Heard of Bank Nifty? It's a basket of 12 top liquid bank stocks. There are also other sector-specific indexes that represent how a particular sector is doing and contain a set of stocks from those particular sectors like tech, health, pharma, auto, power etc.
Why are people obsessed with tracking Sensex and Nifty? When you invest in a random mutual fund and receive a return of say 12%, how will you evaluate if the mutual fund is performing well? You need something to compare this mutual fund's performance to right? So people usually compare the returns from the mutual fund with the returns from Nifty. If the mutual fund does better than Nifty, people see the mutual fund as ''a good investment''.