Buying stocks before they are added to indexes

Discussion in 'Trading' started by cb2301, Nov 15, 2019.

  1. cb2301


    I am investigating buying stocks before they are added to indexes that passively managed funds are designed to track. For example, an equal weight ETF or Index, to maintain weight of its components, may rebalance periodically by buying or selling some stocks. My understanding is that announcements of additions and subtractions are made public (S&P 500 additions are made available after the market close). And the stock price likely increases/ decreases in after hours trading in response to these announcements. I am also wondering if anyone knows where (platforms? websites?) if other indices are making such announcements?
  2. dozu888


    Here is a hint. Any time you get an idea. The first question is how many thousands of people already thought about it. Then you can kill the idea without wasting more time.
    _eug_, dealmaker and Snuskpelle like this.
  3. Mostly agree. If you are really good, you might be able to improve the signal using it as an input to another. For a quant studying market impacting features it's still relevant even if all basic strategies have no alpha left.
    Last edited: Nov 15, 2019
    dealmaker likes this.
  4. WealthSignals

    WealthSignals Sponsor

    In any case one should backtest the idea prior to putting money on the table. In Wealth-Lab software it's possible to use survivorship bias free historical EOD data (from Norgate Data or Wealth-Data, for example) which provides access to historical index constituents. It should be possible in general to create a strategy with rules like "enter a position X bars before a stock enters a market index" etc. Although it may look like peeking into the future it's not because additions and exclusions are usually announced ahead of time. -Eugene
  5. tomorton


    This is a long-standing tactic to stock-picking.

    In the UK, a study by Smith’s Corporate Advisory showed that, on average, stocks heading for relegation from the FTSE100 lost nearly 19% in the two months prior to the announcement date. Similarly, companies that made it into the FTSE100 enjoyed average gains of more than 15% in the run-up to the announcement date, then another 2% up to the actual joining date. This is partly down to funds that track the FTSE100 having to sell or buy stocks that leave or join.

    The FTSE100 is reshuffled every March, June, September and December. Its not impossible to see which companies are most likely to be announced for promotion as that date approaches but by the time its taken place the change in status has been mostly priced in.

    Maybe the same pattern would emerge for your chosen index?
  6. WealthSignals

    WealthSignals Sponsor

    As for German indices like DAX, MDAX or SDAX, I can tell that Deutsche Borse makes announcements weeks ahead. They rebalance on a quarterly basis (except for unscheduled changes, of course). -Eugene
  7. Actually I just saw some results on the idea. Tested with Wealth-Lab and Norgate data on SP100 in a quick and dirty way. Before publishing it here, I would like to verify a few things first. So far it looks good.
    Last edited: Nov 18, 2019
  8. I love testing those ideas... that we all had before or heard about. So this test is not scientific, but it could be an indication. Anyway we tested on the SP100, from 2000 until today we counted 90+ companies coming in and others leaving the SP100. We tested several setups.

    1. Buy four days before a stock gets into the index
    2. Sell the day after a stock got into the index
    See screenshot Wealth-Lab 1

    Wealth-Lab 1.png

    Position size 10K
    Norgate Data
    Win Rate 69.57%
    Average Profit % 1.65%
    Maximum Drawdown -$3,757.88
    Maximum Drawdown Date 12/15/00
    Profit per Bar $32.76
    Profit / Total Bars $3.01

    Whats interesting here is, that the Profit per bar on this strategy is much higher than the average buy and hold profit per bar.

    On the second screenshot you see how it would have been if you would buy the stock 10 days before it gets into the index. You see that it profit is much higher, however keep in mind that most announcements are of index changes are only 4-5 days prior. So unless you know something... ;)
    See screenshot WealthLab 2

    WealthLab 2.png

    Position size 10K
    Same data
    Win Rate 64.84%
    Average Profit % 3.00%
    Maximum Drawdown -$5,345.34
    Maximum Drawdown Date 12/04/00
    Profit per Bar $27.07

    I would not consider this a complete research but a start. I must admit that with our own WealthData the results weren't that good but in the same range. There are several reasons for it that make the difference we know about it.

    In any case the strategy gives you an edge but it seems too little profit and too seldom opportunities to make a living - at least on the SP100.

    I look forward to see your comments here.

    WealthSignals likes this.