Page 183 - THE MARKET WHISPERER

THE MARKET WHISPERER 17 9

Rebalance: How to Profit from
Index Updates

Once each year, the research organizations Standard & Poor’s, Dow Jones,
and NASDAQ undertake a joint review of the composition of companies
included in the indices they manage. When a specific company is
encountering difficulties and its stock has plummeted, it is highly probable
that this company will be removed from the list and replaced by a “new
star.” Stocks such as Apple and Google did not always appear on the index,
but made their entrance due to strong successes and to ousting stocks that
were doing poorly or were completely inactive.

Why does this need to interest you? For two reasons: first, never believe
a person who says something like, “If you had invested $1000 in the Dow
Jones 30 years ago, you’d be rich today.” That’s no less than fraud, used
by Wall Street salespersons and fund managers trying to solicit you into
a long-term investment. In actuality, the index changes annually since
stronger stocks replace those doing poorly. If you’d have invested in the

original index, you’d have lost a lot of money by now.

The second reason is based on a known trading method: many funds
link to an index. For example, a fund may promise its investors that it
will only invest in stocks belonging to the S&P 500 index. When a stock is
removed, the fund is forced to sell it and instead buy the stock moving into
the list.

So far, so good. Do I need to detail how money is made from this activity?
Since the information concerning stocks being removed and entered into
the index is publicized several weeks before the actual update, the funds
are forced to sell and begin buying in advance. In other words, a stock
being removed from the index will drop, since the funds are forced to sell
it; a stock entering the index will rise, since the funds are forced to buy it.
It’s that simple. Type the term “S&P Rebalance” into your search engine
to find the dates and precise list of stocks leaving and joining the index.