Trading the Russell 2000

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The New York Stock Exchange and the NASDAQ saw exceptional volume as speculators were trading the Russell 2000 during the one day a year when the medium and small cap fund rebalances. The Russell 2000 is a small and mid capitalization stock market index consisting of the bottom two thousand stocks in the Russell 3000 index. Although the Russell 3000 consists of roughly 98 percent of US stocks the Russell 2000 stocks have capitalizations of up to around $1.4 Billion USD and account for about ten percent of all capitalization in the Russell 3000. When the Russell 2000 rebalances it removes stocks whose capitalization has gone up above its upper cutoff and also removes stocks that have gone out of business or are not longer traded on the major stock exchanges. Trading the Russell 2000 when it rebalances is a means of trading the rallies and retreats of the stock market albeit a yearly opportunity.

When the Russell 2000 rebalances, a large number of funds that track the Russell 2000 also rebalance their portfolios. Exchange traded funds such as iShares, ProShares, Direxionshares, RydexShares and many others buy and sell large number of shares in order to rebalance their portfolios to stay in line with the Russell 2000. Trading the Russell 2000 during the once a year rebalancing lends itself to scalping versus momentum trading although throughout the year funds that track this index are a reasonable means of trading the fortunes and trends of the broad range of small and mid cap stocks.

The average market capitalization for stocks in the Russell 2000 is around $530 million and the median is around $410 million. Currently any stock at or above $1.4 billion in market capitalization is at risk of being sold in large volume as it is “balanced” out of the Russell 2000. Although the Russell 2000 only rebalances once a year it is a good example of where the trader does not need to be trying to outguess the market. The cutoffs are fairly clear for the stocks involved, especially for stocks that have prospered in the last year. They will likely be sold in high volume as they are removed from the Russell 2000. This year the volume was impressive with a Friday closing cross volume of 1.04 billion shares in 0.85 seconds!

While the trading the Russell 2000 in this way only works once a year the S&P 500 rebalances quarterly. This occasion also leads to heavy volume as the S&P rebalances its list of five hundred large capitalization stocks. In this case stocks obviously do not escape off the top end but do fall off the bottom if their earnings and stock values suffer sufficiently to be replaced by up and coming companies. Trading both the Russell 2000 and the S&P 500, as they rebalance, has less to do with technical analysis than it has to do with simply looking at each index’s criteria for inclusion and deciding who will likely be replaced in or added to the index in question. Once the trader has chosen his “targets” then a look at the technical aspects of the market and timing will come into play in trading the Russell 2000.