What is the Bank Nifty?
Bank Nifty is a stock market index that tracks the performance of the banking sector in India. It was created by the National Stock Exchange (NSE) in 2003 to provide a free flow movement of the capital market performance of one of the critical service sectors of India, i.e., banking. The index comprises 12 state-owned and private sector banks. Like the Nifty, those bullish on banks can buy Bank Nifty futures comprising 15 shares or buy a call option on Bank Nifty. Bears can similarly short or sell Bank Nifty futures or buy a put option on the index. The Bank Nifty is more volatile than the Nifty futures contract. Traders who hold bank shares can hedge themselves by taking contra positions on individual banks in the derivatives segment.
Which sectors are covered in the Nifty?
To understand the significance of Bank Nifty, it is essential to grasp the broader context of India's benchmark indices. Nifty, in its entirety, tracks the performance of the top 50 equity stocks traded on the National Stock Exchange (NSE). These 50 stocks represent a diverse cross-section of India's economy, spanning across various sectors. These sectors include:
- Information technology
- Financial services
- Consumer goods
- Entertainment and media
- Metals
- Pharmaceuticals
- Telecommunications
- Cement and its products
- Automobiles
- Pesticides and fertilisers
- Energy and other services
Thus, the Nifty provides a holistic view of India's financial health.
How is Nifty calculated?
The Nifty index is calculated using a free-float market capitalisation-weighted methodology. This means that the weight of each stock in the index is determined by its market capitalisation, but only the free-float shares are considered. Free-float shares are those shares that are available to the public for trading.
The formula for calculation Nifty is:
Nifty = Current market value / Base market capital * 1000 |
For Nifty calculation, the base period is November 3, 1995. The base value is considered as 1000 and the base capital stands at Rs. 2.06 trillion.
The free float market capitalisation is calculated as follows:
Free float market capitalisation = Share price * Equity capital * Investable weight factor (IWF) |
Nifty bank scrip selection criteria
Understanding the Nifty Bank Scrip selection criteria helps you gain insights into how the index is structured and maintained. Here’s a break-down of the selection criteria used for the Nifty Bank selection criteria:
1. Liquidity of the stock
A stock must have substantial liquidity in terms of trading volumes to be included in the Nifty Bank Index. High liquidity is prioritised since it ensures efficient price discovery. In other words, the supply and demand dynamics in the market are accurately represented in the stock’s price. Liquidity is a primary criterion for the Nifty Bank Index since it ensures that the index is always responsive and relevant to market changes.
2. Market capitalisation
The market capitalisation of a stock plays a crucial role in determining its inclusion in the Nifty Bank Index since it is a direct measure of a company’s size and influence in the concerned industry. Thus, to be included in the index, a stock should have a market capitalisation that’s large enough to represent a sizable banking industry segment.
3. Sector representation
The Nifty Bank Index aims to offer an accurate and comprehensive overview of the Indian banking sector. The selection criteria for the Index aims to represent this diversity by considering the representation of both public and private sector banks and other financial institutions. This diverse mix helps ensure that the Index correctly represents the overall health and performance of the Indian banking sector.
4. Corporate governance
The Nifty Bank Index evaluates the company’s track record of corporate governance during the selection process. Stocks of companies that demonstrate transparent practices and ethical management are preferred since they help boost investor confidence in the Index.
5. Financial performance
The financial performance of companies is given significant weightage to ensure the inclusion of the most stable performers in the banking sector. The index includes companies with a track record of consistent profitability and good financial health.
How the Bank Nifty index is used?
Bank Nifty is not merely an observation tool; it is a versatile instrument employed for several purposes. Its pivotal roles include:
1. The index as a benchmark
The bank Nifty serves as a benchmark for investors, providing insights into how banking stocks are expected to perform in general. It is a guiding light for investors to make informed decisions and to anticipate whether specific funds will yield profits or losses.
2. The Bank Nifty for options trading
The index is actively engaged in options trading, empowering traders to leverage price fluctuations within the banking sector. Traders employ various options trading strategies, including straddles and strangle, to profit from market volatility.
3. Benchmarking fund portfolios and financial products
Bank Nifty serves as a benchmark for fund managers, allowing them to assess the performance of mutual funds. Moreover, it provides the ideal foundation for the creation of financial products such as index funds, exchange-traded funds (ETFs), and structured products. These investment vehicles offer diverse options for investors, each with its unique features and benefits.
4. Technical analysis with the Bank Nifty
Technical analysis, a cornerstone of investment, plays a pivotal role in understanding market dynamics. The Bank Nifty chart serves as a canvas for investors to identify patterns, analyse trends, and assess the strength and persistence of market trends.
Benefits of investing in the Bank Nifty
Investing in the Nifty Bank Index can be beneficial for investors who seek to optimise their investment portfolios. Investing in the Nifty Bank Index is prudent for the following reasons:
- The banking sector is a critical and growing component of the Indian economy. The Nifty Bank Index offers investors exposure to some of the major banking stocks in the Indian economy, allowing them to partake and capitalise on the sector’s growth.
- Investing in the Nifty Bank Index allows you to invest in a range of diversified banking stocks at once. This helps mitigate the risk of investing in just one company and, thereby, the impact of a stock’s poor performance on your overall portfolio.
- Since liquidity is a key selection criterion for the Nifty Bank Index, the index offers ample liquidity to investors. In other words, you can easily buy and sell shares, enjoying maximum flexibility on your investment.
- The Nifty Bank Index is very closely monitored and well-recognised, making it a crucial benchmark that investors can use to evaluate the performance of their investments. Investors can identify trends and market patterns to make informed investment decisions based on the performance of the Nifty Bank Index.
The stockpile of the Bank Nifty
At the heart of Bank Nifty are 12 significant stocks that represent the banking sector. However, the top stocks currently comprising the Bank Nifty index are:
- HDFC Bank Ltd.
- ICICI Bank Ltd.
- Axis Bank Ltd.
- Kotak Mahindra Bank Ltd.
- State Bank of India
- IndusInd Bank Ltd.
- AU Small Finance Bank Ltd.
- Bandhan Bank Ltd.
- Federal Bank Ltd.
- IDFC First Bank Ltd.
- Bank of Baroda
- Punjab National Bank
Conclusion
The Bank Nifty is used as a benchmark for investors and mutual fund managers to gauge how banking stocks will perform in general and whether certain funds are likely to make gains. It is also used as an underlying asset for derivatives trading such as futures and options contracts. Traders can use Bank Nifty futures contracts to speculate on future price movements or hedge their existing positions in bank shares. The Bank Nifty is more volatile than the Nifty futures contract due to its narrow focus on banking stocks.
Investors should exercise caution when dealing with the Bank Nifty, as it is known for its heightened volatility. The value of investments can fluctuate significantly, and careful risk management is essential.
As you navigate the world of trading and explore investment opportunities, consider starting your journey with Bajaj Financial Securities.
