Rebalancing Trading Strategy

Russell 2000 Rebalancing Trading Strategy (Backtest and Analysis)

The Russell 2000 Rebalancing Trading Strategy is a method that takes advantage of the abnormal outperformance of the Russell 2000 index during its annual rebalancing at the end of June. Traders buy on the close of the first trading day after June 23rd and sell on the close of the first trading day of July, capitalizing on the rally that typically occurs during this period.

Russell 2000 rebalancing at the end of June is an important event. It’s important because it leads to potential imbalances, but more importantly, the Russell 2000 has shown abnormal outperformance over these few days. The seasonality and effect are so strong it seems to be a tradeable Russell 2000 rebalancing trading strategy.

In this article, we test how the Russell 2000 rebalancing at the end of June leads to a rally in the last few days of June. It turns out the seasonality is for real. Our result suggests the Russell 2000 performs much better at the end of June than any other period of the year. We present a Russell 2000 rebalancing strategy based on the imbalances and effects.

What is the Russell 2000 Index?

The Russell 2000 Index is a stock market index that measures the performance of approximately 2,000 small-cap stocks in the United States. It’s used as a benchmark for tracking the performance of small-cap companies and is often seen as a barometer for the overall health of the U.S. economy.

As the name implies the index has 2 000 stocks included. It’s regarded as a small-cap index. The reason for that is that Russell 2000 is a subset of the smallest companies in the Russell 3000 Index which tracks the largest 3000 public companies. Russell 2000 is a market-weighted index. The ticker for the index is RUT, the ETF has the ticker IWM, and the futures contract is RTY.

The name Russell is a result of the Frank Russell Company that established the Russell indices back in 1984. It’s now owned by FTSE Russell, a UK company.

Despite having 2000 companies included, the index has just 10% of the overall US market capitalization. Thus it’s being used as a small-cap gauge of the market.

What are the biggest Russell 2000 components?

The ten biggest holdings are currently these: OVV, AR, CHK, SWN, BJ, RRC, PDCE, BHVN, WSC, and MTDR.

When does the Russell 2000 rebalance?

The Russell 2000 Index typically undergoes an annual rebalancing process. The exact date can vary, but it commonly occurs in June. During this time, the index is adjusted to ensure that it accurately represents the small-cap segment of the U.S. equity market.

Rebalancing involves adding new companies that meet the index’s criteria and removing others that no longer qualify, as well as adjusting the weights of existing constituents. This process helps maintain the index’s integrity and relevance to investors.

Every year on the fourth Friday of June, the Russell 1000, Russell 2000, Russell 3000 and other Russell indexes are reconstituted. (FTSE Russell gives investors a heads up about what moves they should expect.)

Russell 2000 rebalances their holdings once per year on the fourth Friday of June. The date of the fourth Friday varies, obviously, so traders are advised to look at Russell’s website to find out when.

What does Russell 2000 rebalancing mean?

Russell 2000 rebalancing means adjusting the constituents of the Russell 2000 index to maintain its representation of small-cap stocks according to predetermined criteria.

Russell 2000 rebalances their holdings at the end of June every year. Here is what they said about rebalancing some years ago:

June is the month that the preliminary reconstitution portfolio is communicated to the marketplace. Beginning on June 9, preliminary lists are communicated to the marketplace and updates are provided on June 16 and 23. The newly reconstituted indexes take effect after the close on Friday, June 23.

The Russell 2000 needs to rebalance its holdings in order to reflect the universe it’s supposed to cover. The Russell 2000 is a highly anticipated event and captures the changes over the last year in the mid and small-cap universe.

Why does Russell 2000 rebalance?

Russell 2000 rebalance to ensure that the index accurately represents the performance of small-cap stocks and maintains its intended composition.

The purpose of an index is to mirror the returns of a market or asset class. Each index has a stated methodology, and obviously, from time to time the index needs to reflect the methodology.

This means some securities need to be bought and others sold – no matter if the index is market-weighted or equal-weighted. Over the course of time, some stocks rise in value and others decrease in value.

For example, The Russell 2000 measures the performance of the small-cap universe. The index is market-weighted and rebalanced annually to reflect the changed market capitalization of the underlying stocks since the previous rebalancing last year. The Russell 2000 rebalances only once per year – in June. In 2021 it was done on Friday the 25th of June.

A rebalancing might lead to imbalances. For example, as of writing, Gamestop is one of the stocks that has risen a lot during the last year and the managers need to buy more shares in Gamestop. This might lead to a buying imbalance where there are not enough sellers, or the price need to go up to attract more sellers. Thus, we have an imbalance.

Vice versa for those stocks that need to be reduced.

Overall, this means many buys and sells in June for many small caps. But interestingly, the Russell 2000 rebalancing has led to an overall rally for the index in the last days up until the close of the first trading day of July.

How often do indices rebalance?

Indices rebalance periodically, typically quarterly, semi-annually, or annually, depending on the specific index methodology.

How often an index rebalances is started in the methodology. The S&P 500 is rebalanced four times per year, while the Russell 2000 rebalances only once a year.

How does Russell 2000 rebalance the index?

Russell 2000 rebalances the index annually in June. To rebalance is, in principle, very easy. If the methodology says Gamestop should be five percent of the index but is currently only four percent, the managers need to add one percent.

Even though it’s easy, the managers need to buy and sell in the market. And this is why we might experience imbalances.

We test the following Russell 2000 rebalancing trading strategy:

In order to test the Russell 2000 rebalancing trading strategy we backtest the idea below to check the outperformance of the Russell 2000 at the end of June.

We make the following trading rules:

Trading Rules

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The backtest is pretty simple. We test on free data from Yahoo/finance by using the tickercode ^RUT which is the cash index of the Russell 2000 and doesn’t include dividends.

We compare the result to the cash index of the S&P 500 (^gspc). The test period starts in 1988.

Is there any rally/effect in the Russell 2000 index due to the rebalancing?

Our trading strategy says the average gain for the Russell 2000 in late June is 1.34%. That is well above any random period of the year for the index. The average holding time is 6 trading days.

The equity chart looks like this from 1988 until today:

Russell 2000 rebalancing trading strategy
Russell 2000 rebalancing trading strategy

The trading performance metrics look like this:

Worth noting is that Russell 2000 shows no positive performance up until the 23rd day of June. June is a poor month for the stock market, thus making the end of June rally/effect the more powerful. Thus, the Russell 2000 rebalancing plays a major role in June.

July is included in the performance because we exit at the close on the first trading day of July.

For comparison, the S&P 500 has gained an average of 0.85% during the same period.

The Russell 2000 rebalancing effect when hedged with the S&P 500

What does the Russell 2000 rebalancing trading strategy look like if we go long the Russell 2000 but hedge with a short position in the S&P 500?

One of the reasons for the strong performance of Russell 2000 during the end of June might be the overall strong market. The S&P 500 has risen 0.8% on average during the same period. Thus, we might argue that Russell 2000 outperforms simply due to the small-cap effect.

Here’s how it looks:

A hedged position didn’t perform well the first 12 years.

Here are the annual hedged returns:

Amibroker code:

If you would like the Amibroker code (Tradestation code is added gradually) for this strategy plus the code and logic for 70 other free trading strategies, please click on this link:

Russell 2000 rebalancing strategy- conclusion:

The Russell 2000 rebalancing trading strategy has led to a significant end-of-June rally/effect that could be a valuable tool for any trader. Our trading strategy using the Russell 2000 rebalancing seems to work pretty well. Even though it happens just once per year, it’s easy to implement in your trading arsenal.

Click here for more: IWM Trading Strategies and Russell 2000 strategies.

When does the Russell 2000 rebalancing occur?

The Russell 2000 rebalances its holdings once a year on the fourth Friday of June. The specific date varies from year to year, so it’s essential to check Russell’s website for the exact date.

Why does the Russell 2000 rebalance its holdings?

The primary purpose of rebalancing is to ensure that the index accurately reflects its intended universe. Changes in market capitalization and stock values necessitate adjustments to the holdings to maintain the index’s integrity.

What happens during the Russell 2000 rebalancing?

During the rebalancing process, stocks that have appreciated or depreciated are bought or sold, respectively, to maintain the index’s desired composition. This buying and selling can lead to temporary imbalances in the market.

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