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A lot of investors are going to be surprised by the huge spikes in volume that many stocks are going to see near the close this Friday. Some will wonder whether it's another sign of market manipulation. But don't worry: It's all perfectly normal, although it does give you an opportunity to get in on some interesting stocks before the investing masses do.
Playing index games one more time
Every June, Russell Investments, which is the company behind the well-known small-cap benchmark Russell 2000 index, changes its lists of component stocks for several of its indexes. Inevitably, the index reconstitution leads to some up-and-coming companies making it into the benchmarks, replacing those companies that no longer qualify for inclusion.
Given that this happens every year, you'd think that everyone would treat it as a non-event. But with nearly $4 trillion of institutional investments tied to Russell's indexes, there's a ton of money at stake -- and with the many index funds and other money managers that have to follow Russell's moves, you can expect to see substantial volatility as the changes become final on June 24.
This year, arguably the most significant addition to the Russell 3000 index will be General Motors. After going bankrupt following the financial crisis, the company's IPO gave GM a $44 billion market cap. It's not unprecedented for large companies to get left out of the index for at least a while, but typically, the omission gets remedied at the earliest opportunity -- as is happening here.
But although GM may be the best-known name on the list, you'll find plenty of other promising stocks as well. Cloud-based phone company 8x8 (Nasdaq: EGHT ) , oil and gas exploration company Hyperdynamics (AMEX: HDY ) , and specialty retailer ZAGG (Nasdaq: ZAGG ) , which is best known for making protective covers for iPhones and other personal electronic devices, are all on the preliminary list to get added to the index.
Getting added to the list doesn't ensure success, of course. Quepasa (AMEX: QPSA ) is also on the tentative addition list, but its prospects are still in question. Despite its status as a public social networking company, it has fewer users and far less traffic than better-known sites and seems unlikely ever to close the gap significantly.
Joining the Russell 3000 may not be as difficult as being the last Highlander, but its name tells you the most important rule: There can be only 3,000. That means for every addition, you need a stock to leave. Sometimes, mergers and acquisitions make room for new stocks, but you'll always find at least some stocks that get the boot.
This year's tentative hit list includes Delta Petroleum (Nasdaq: DPTR ) , MELA Sciences (Nasdaq: MELA ) , and Advanced Battery Technologies (Nasdaq: ABAT ) . Although the reasons for each company's declines differ, they all share one thing in common: They've seen significant drops in their stock prices, and their market caps are now low enough to warrant getting downgraded to microcap status.
What's going to happen?
All the fuss these and many other stocks will see later this week stems from the institutions that track Russell's indexes. For instance, index funds that try to mimic the performance of the Russell 3000 will have to buy all the new additions to the index while selling their holdings in the stocks that are leaving.
Especially with smaller-cap stocks, which aren't always very liquid, the huge amount of institutional attention can move markets substantially in the short run. So if the stocks that are new additions to the index interest you, you may want to buy them today rather than waiting until next week. On the other hand, if you think they've come too far too fast, then waiting a while to take advantage of share-hungry index funds might get you a better price.
The advantage of investing in individual stocks is that you get to call the shots on when and how you buy. Although index funds are useful, this is their weakness -- and with a little effort, you can exploit their mindless buying and selling later this week.
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