Have you ever seen a stock price fall all of a sudden, but don't know why. There was no bad press, they didn't just report lower than expected earnings, it just dropped?
One reason is due to index fund rebalancing, and I'll tell you what that means.
ETFs and Funds
A Mutual Fund is a bundle of shares that are traded as a single investment.
An ETF is the same, except it's traded on the open market, thus the name, an Exchange Traded Fun.
These are both methods for diversifying your investments easily, when you buy shares in an ETF you are investing in a number of companies at the same time.
Funds are a great way to diversify your investments without the effort of actually buying a whole bunch of individual company shares.
An Index
An index is a way to track the performance of a bundle of shares as a single value.
Anyone can create their own index, it’s just a weighted average price of any combination of stocks, tracked over time.
Some indices are very well known, you've probably heard of the S&P 500.
Well the S&P 500 is an index that tracks 500 of the leading companies in the US.
Index Funds
Many funds don't make up their own bundle of shares, they use someone else's bundle. An index fund is a fund that invests in a bundle of companies matching the bundle tracked by a particular index.
This means the fund actually buys shares in each of those companies.
Some common ETF providers are also well known, like iShares, BlackRock, and Vanguard. Each of them has an ETF based on S&P indices like the S&P 500 or the S&P Small Cap 600 index.
Index Fund Rebalancing
We like to assume that the value of a stock on the market is based on fundamental factors related to how well that company is run and it’s future prospects for profitability and growth.
But an index is not static. They do what's called rebalancing, that is, updating their index to add or remove certain companies.
Now the problem here is that if S&P decides to change their index to remove a company and replace it with a new one, then all of those ETF providers need to update their investments to match.
This means that some of the largest investors in the world all suddenly and simultaneously sell shares in one company and buy shares in another company.
And of course if massive quantities of a particular companies shares are for sale all of a sudden, no surprises here, the price drops.
The company didn't do anything especially good or bad, but their stock price either got a nice bump or took a nose dive, because someone managing a popular index decided to they were or weren't worthy.