REAL WORLD

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Profit In Puget Sound?

The Russell Reconstitution: Plan For 2008

by Don Bright

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Are there still profit-making opportunities in the Russell2000? Find out here.

There has been a lot of discussion aboutthe "Russell reconstitution" and whether there would still be a good profitopportunity for professional traders. Some have opined the "edge is gone,"but I am here to say, "No, it isn't." I have hundreds of traders, manyof whom made excellent money using various strategies, all focusing onthis event.

RECONSTITUTION

First off, here's a basic description of what we're talking about. Eachstock market index is composed of individual stocks. The Dow Jones IndustrialAverage (DJIA) has only 30 stocks, and the Standard & Poor's 500 holds500, obviously. The Russell 2000 is made up of 2,000 small- to medium-capitalizationcompanies (1,001st through the 3,000th largest domestic stocks as judgedby market capitalization). The reconstitution is simply the replacementof certain stocks with others. You have "adds" and "takeouts." The mostrecent replacement day was June 22, 2007.

The reasoning behind the concern about making profits was based on thefact that the stocks being swapped are known well in advance of the actualevent. This is not the case with the S&P 500 (they use a closed approach).This knowledge leads to what is referred to as "front-running" -- buyingthe adds and shorting the takeouts ahead of the event. Bright Trading hadtraders who did, in fact, begin their trading weeks ahead of the June 22nddate. Our people tended to close most positions ahead of June 22 profitablyand then take a clean slate for the actual event. Simply knowing the newcomposition of stocks ahead of time is not enough to guarantee profits("guarantee" is a tough word to use in this business anyway), but whencombined with some market savvy, access to enough capital (via professionalcapital-use capabilities), our traders did very well.

A CHANGE IN TREND

Why did our early group make money? This is due in large part to increasedliquidity in these issues. When a good trader sees an obvious change intrends of these particular stocks, they can play these trends with a noncorrelated-pairstrategy. The stocks being taken out are generally the weaker stocks andvice versa for the stocks being added. Being able to take home these currentlystronger stocks, in several layers, offers them the ability to "ride thewave" of the moving average convergence/divergence (MACD) and just plaindivergence.

...Continued in the March issue of Technical Analysis of STOCKS &COMMODITIES

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Excerpted from an article originally published in the March 2008issue of Technical Analysis of
STOCKS & COMMODITIES magazine. All rights reserved. © Copyright2008, Technical Analysis, Inc.

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