Financial Management and Business Data Analytics · Capital Market

Stock Market Indices and Market Efficiency Explained

Updated 10 October 2026 · Fact-checked

A stock market index measures the combined movement of a basket of shares. Most Indian indices, such as Sensex and Nifty, weight each share by its free-float market capitalisation. Market efficiency means prices reflect available information. The Efficient Market Hypothesis has weak, semi-strong and strong forms. Solve questions by identifying the formula or the information set involved.

Understand Stock Market Indices and Market Efficiency

A stock market index is a single number that tracks how a chosen group of shares is performing. If the index rises, the shares in the basket have, on a weighted basis, gained value. It gives investors a benchmark to judge their own portfolio and the market as a whole.

Indices differ in how they weight shares. Under price weighting, shares with higher prices count more. Under market capitalisation weighting, larger companies count more. Sensex (BSE) and Nifty 50 (NSE) both use free-float market capitalisation. Free-float market cap counts only shares available for public trading, so it excludes promoter and strategic holdings. Market cap = share price × number of shares. Free-float market cap = share price × free-float shares.

The index value is computed against a base period. The base period has a base value (for example 100 or 1,000), and the current index is the current free-float market cap of the basket divided by the base market cap, multiplied by the base value. Corporate actions and changes in constituents are handled by adjusting a divisor (index divisor), so that the index does not jump for reasons unrelated to price movement.

Sensex is the benchmark index of BSE with 30 large companies. Nifty 50 is the benchmark index of NSE with 50 large companies. Both are broad indicators of large-cap performance. The main differences are the exchange, the number of stocks and the base period, not the free-float method.

Market efficiency asks whether share prices already reflect available information. In an efficient market, new information is absorbed quickly, so it is hard to earn consistently abnormal returns. The Efficient Market Hypothesis (EMH) has three forms. Weak form: prices reflect all past price and volume data, so technical analysis cannot give abnormal returns. Semi-strong form: prices reflect all public information, so fundamental analysis cannot give abnormal returns either. Strong form: prices reflect all information, public and private, so even insiders cannot earn abnormal returns.

Key rules to remember

Market capitalisation: Market cap = Market price per share × Total shares outstanding; Used for full market-cap weighting.
Free-float market capitalisation: Free-float market cap = Market price × Free-float shares; Free-float shares = total shares minus promoter and other locked-in holdings. Used by Sensex and Nifty.
Free-float factor: Free-float factor = Free-float shares ÷ Total shares; A fraction between 0 and 1. Free-float market cap = Market cap × free-float factor.
Index value (market-cap method): Index = (Current free-float market cap of basket ÷ Base market cap) × Base index value; Base value is commonly 100 or 1,000 depending on the index.
Index return: Return % = (Closing index − Opening index) ÷ Opening index × 100; Gives percentage change in the market over the period.
EMH forms: Weak: past prices. Semi-strong: all public information. Strong: all information including private.; Each form includes the information set of the weaker form.

How to solve Stock Market Indices and Market Efficiency questions

Use this method for numerical and theory questions on indices and efficiency.

1Read the question and decide whether it asks for an index calculation, an interpretation or the type of market efficiency.
2For an index calculation, list each company's price, total shares and free-float shares or factor.
3Compute free-float market cap for each company as price × free-float shares.
4Add them to get the total free-float market cap of the basket.
5Apply index = (current total ÷ base total) × base value, or compute percentage change between two index values.
6For EMH questions, identify the information that is said to be useless (past prices, public data or private data) and match it to the weak, semi-strong or strong form.
7State the conclusion in one line, such as what it means for the investor or analyst, with units and the word 'points' for index values.

Quickest way: Free-float first, then ratio

When to use it: Use when you must compute an index value or index change in a time-limited exam.

Write free-float cap for each stock in ₹ crore or lakh in a small table.
Total them once for the current period; the base total is usually given.
Divide current by base and multiply by base value.
For EMH, link the form to the information: past prices = weak, public = semi-strong, insider = strong.
Cross-check that the answer is plausible: a higher total than base must give an index above the base value.

Common mistakes in Stock Market Indices and Market Efficiency

Using total shares instead of free-float shares for Sensex or Nifty.
Students remember the market cap formula and apply it automatically.
Fix: Check the question for the words free-float or promoter holding. If present, use only the public shares.
Treating Sensex and Nifty as having different weighting methods.
Both are mentioned as separate indices so students assume the method differs.
Fix: Remember both use free-float market cap. The differences are the exchange, number of stocks and base details.
Mixing up weak and semi-strong form efficiency.
Both mention that analysis is useless, and the information sets sound similar.
Fix: Weak form concerns past prices and volume only. Semi-strong adds all public information such as results and announcements.
Saying insiders can earn abnormal returns in a strong-form efficient market.
Students recall insider trading cases and ignore the definition.
Fix: Strong form means all information, including private, is already in the price, so even insiders cannot earn abnormal returns.
Forgetting to multiply by the base value in the index formula.
The ratio looks like the final answer.
Fix: Always finish with × base value, for example × 100 or × 1,000, as the question states.
Writing index change in ₹ instead of points or percentage.
Students are used to money answers in the paper.
Fix: Index values are points. Express changes in points or as a percentage.

Worked examples

Example 1

A basket has two companies. Company A: price ₹500, total shares 10 crore, promoter holding 60%. Company B: price ₹200, total shares 20 crore, promoter holding 25%. Base free-float market cap is ₹3,000 crore and base index value is 100. Compute the current index value.

Show the solution

Company A free-float shares = 10 crore × (1 − 0.60) = 4 crore.
Company A free-float cap = 500 × 4 crore = ₹2,000 crore.
Company B free-float shares = 20 crore × (1 − 0.25) = 15 crore.
Company B free-float cap = 200 × 15 crore = ₹3,000 crore.
Total current free-float cap = 2,000 + 3,000 = ₹5,000 crore.
Index = (5,000 ÷ 3,000) × 100 = 166.67.

Answer: The index value is about 166.67 points.

Example 2

An analyst studies past share price charts and finds that buying after a rise gives no better returns than buying at random. Another analyst finds that studying published annual results also gives no abnormal returns, but a director with unpublished news does earn them. Which form of the Efficient Market Hypothesis is supported, and why?

Show the solution

The first finding shows past prices carry no useful information, so the weak form holds.
The second finding shows public information such as annual results is already in prices, so the semi-strong form holds.
Directors with unpublished information still earn abnormal returns, so private information is not in prices.
Therefore the strong form does not hold.

Answer: The market is semi-strong form efficient (and therefore weak form efficient), but not strong form efficient.

Exam tips

Practise one index table with free-float shares given as a percentage; this is the usual numerical pattern.
In theory answers, write the three EMH forms with the information set and the implication for technical and fundamental analysis.
For a difference between Sensex and Nifty, write exchange, number of constituents and base period, and note both use free-float weighting.
Show each company's free-float cap line by line so you earn step marks even if the last division slips.
Use MCQ keywords: past prices = weak, public = semi-strong, insider = strong.

Practice questions from Capital Market

Stock Market Indices and Market Efficiency in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

NISM CertificationsIntroduction to Stock Market Indices

Stock Market Indices and Market Efficiency: frequently asked questions

What is the free-float method in stock market indices?

It weights each share by its price multiplied by only the shares freely available for public trading. Promoter and other locked-in holdings are excluded. This makes the index reflect what investors can actually trade.

What is the difference between Sensex and Nifty?

Sensex is the benchmark index of BSE and has 30 companies. Nifty 50 is the benchmark of NSE and has 50 companies. Both use the free-float market capitalisation method.

What are the three forms of the Efficient Market Hypothesis?

Weak form says prices reflect all past price data. Semi-strong form says prices reflect all public information. Strong form says prices reflect all information, including private information.

Can technical analysis work in a weak-form efficient market?

No. If past prices are already reflected in current prices, patterns in charts cannot give consistent abnormal returns. Fundamental analysis might still work in a market that is only weak-form efficient.