The Russell Index Trade

Market players will be busy today trading the stocks that will be added or deleted from the Russell Indexes. This event happens annually and investors who wish to take advantage should focus on buying the companies that are being added and shorting the stocks that are due to be deleted.



Exchange traded funds and mutual funds that track the indexes must rebalance their portfolios to match these additions and deletions so this one of the few market events that you can predict with reasonable certainty which stocks will have above average buying or selling. For a complete list of which stocks, refer to these links. (Additions, Deletions) For a complete description of the process refer to this link (Russell 3000 reconstitution).



In the past traders have taken advantage of the buy or sell imbalances near the close of the trading day that the rebalancing takes place, which takes place later today. This year will see about 277 changes to the index so there is no shortage of ideas for investors looking for new positions. Also, investors need to recognize the fact that the changes are made because the newer stocks that are added are considered to be better representations of their industry groups while the stocks that are deleted are no longer in favor as industry group representatives.



This link examines what happened in 2002 when the S&P 500 changed 9 components in it's index and the performance of those stocks around the rebalancing date. (SP500 rebalance).



Investors who are new to the game should proceed cautiously with regards to this market strategy unless they have the tools to see exactly which stocks are experiencing imbalances prior to close of the trading day. However, if an investor has a longer term objective, this event can help confirm any decisions of whether to buy, hold or sell the stocks involved.



Finally, while I was surfing the net to get information for this post, I came across David Neubert's post from 2006 in regards to this trade. (David's post)

Time to Short the Market?

Market players are facing plenty of reasons to exit positions and avoid any near term selloff in the coming weeks. Geo-political instability in the oil markets and rising interest rates are putting pressure on stocks and the lack of a strong follow through on the recent retracement has given traders a clear signal to avoid long positions while taking a breather. With earnings season around the corner, it is going to take some very strong results or hints of lower interest rates to come, before this market finds it's way to new highs.



When these occasions arise, the ultra-short ETFs that track the major market indexes are a great way to hedge current portfolios without exiting all an investor's long holdings. The three funds that track the Dow Jones 30 Industrials, the S&P500 and the Nasdaq 100 are, respectively, DXD - The Ultra-Short Dow 30 Proshares, SDS - The Ultra-Short S&P 500 Proshares, and QID - The Ultra-Short QQQ Proshares. The funds strategies are leveraged so that they track the major indices at twice the rate of their individual moves. If for example, the Dow Jones Industrial Average falls 1 percent for the day, the DXD - Dow 30 Ultra-Short Proshares, should rise by 2 percent for the day.



Now as for how much size to take in relation to your portfolio, this trader generally believes that a hedge position should not exceed 30 percent of the overall portfolio, unless the position creates a "true neutral" overall position in the market. If not, then the hedge position should not exceed 15 percent of the overall portfolio. For purposes of tracking, I will update readers on positions of 200 shares each representing a total investment just under $30,000 which would be roughly 30 percent of my model portfolio.



The positions I executed when the indexes and where the funds were trading at the time of execution.



Dow Jones 30 Industrials - 13,652.55 - 200 shares of DXD $48.82

S&P 500 - 1533.87 - 200 shares of SDS $51.01

Nasdaq - 1946.82 - 200 shares of QID $45.50