Here’s What You Need To Know About Trading A Stock Being Added To An Index
The
relatively low-volume consolidation over the last few days has done
nothing to discourage my bullish stance. I still believe the long-side is the
place to focus.
Today I’d like to discuss some
recent action in LCA Vision (LCAV). (For disclosure purposes, my firm is active
in this stock.) LCAV broke out of a basing formation on strong volume on
11-15. After a quick stair-step higher, the action became erratic-looking
starting on 11-24. Let’s examine why…
On 11-24 it was announced that LCAV would be joining the S&P 600. This was seen
as good news for the stock. The reason is that some money is indexed to the S&P
600 — IJR for example. Any funds or ETF’s that track the S&P 600 would need to
purchase LCAV for inclusion in their portfolio.
This is what caused the gap up
on 11-24. Many times when index addition/deletion news is announced, some
traders or hedge funds may try and play that stock to see if they can make some
money from it. The basic idea is that you buy the stock anticipating that the
price will move up in a few days because so many people are going to be
forced to buy it at the close on the day it enters the index.
Unfortunately, this is a very old and well known game that no longer is the easy
opportunity it once was. The result these days is typically just some volatile
action before joining the index.
Now look at what happened on
the 30th, when all the indexers had to buy LCAV. It dropped like a
rock. Can you think of any reasons this might happen? Here’s a couple — 1)
Those people that bought it on the 24th anticipating a run-up all
sold it on the 30th when their trade idea “expiredâ€. This mass
selling helped push the price down. 2) Those people that were going to be
buying it at the end of the day aren’t stupid. Do you think they’d try and prop
it up, or encourage a further sell-off?
Some purely technical traders
that didn’t understand the news may have been scared by the huge-volume down day
on the 30th. This could have caused them to panic sell, or raise
their stop to a too-close level (such as below the 11/19 swing low). Those who
understood what was happening were able to evaluate the action with less
emotion. At the close today, LCAV was trading very close to where it was when
all this nonsense started. Big-volume unusual action from here on out should
be watched carefully.
Best of luck with your trading,
Rob
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