Investing in future index constituents: opportunities and pitfalls

When a share is added to a major stock market index, its price can rise dramatically. How can you capitalise on this?

1. What happens if a share is included in an index?

When a share is included in a stock market index, it suddenly attracts a whole host of new buyers. All trackers of the index will have to buy the share. That is because trackers hold the same shares as the index in the same weighting. If the index includes a new share, all those trackers generate a buy order for that share – regardless of the price.

In practice, this leads to huge trading volumes at the time of inclusion. For example, when Tesla joined the S&P 500 at the end of 2020, trackers of that index had to buy more than USD 80 billion in Tesla shares, according to Reuters. This triggered one of the biggest buying waves in a single day in history.

2. How do share prices generally react to an index inclusion?

In many cases, prices already tend to rise in the run-up to a possible index inclusion – especially if there are rumours or signs that a share is likely to be included. Once the official announcement comes, an immediate rally usually follows.

This effect can be significant. For instance, Tesla rose by 14% in a single day in November 2020 when it was announced that it would be added to the S&P 500. Palantir posted +14% in one day in September 2024 following the news of its index inclusion. Coinbase climbed by 24% in one day in May 2025 after the announcement. These increases reflect expectations of increased demand: investors start taking positions before the trackers do, hoping to sell at a higher price later on.

In the days surrounding the actual addition to the index, the price often remains well supported but volatile. It often peaks on the last trading day before inclusion, when trackers rearrange their portfolios. Tesla shares, for instance, peaked to a record high on the day of inclusion, after rallying by as much as 70% in the weeks between the announcement and the actual inclusion.

Some investors choose to sell at the time of inclusion, believing that this constitutes the peak. It is actually not uncommon to see a small pullback just after the inclusion when the mandatory buyers (trackers) have finished buying.

3. Is the price gain due to an index inclusion permanent or only temporary?

There we get a slightly more nuanced picture. People used to think new entrants enjoy a permanent premium, as being included in an index would systematically push up the valuation. However, research by Harvard Business School and others shows that the price effect is largely transitory once the stock has been included. The additional average gain due to an S&P 500 inclusion has fallen from +7.4% in the 1990s to less than +1% in the last decade. In other words, the market almost completely anticipates and eliminates this phenomenon.

Extensive analyses of hundreds of index changes (for example by McKinsey) confirm that share prices typically return to their previous trend levels within 40 trading days of inclusion. On average, a company that is added experiences a brief outperformance (and underperformance following removal), but the effect quickly evens out. In other words, an index inclusion is rarely a game changer in terms of long-term value.

4. As an investor, can you respond to this phenomenon?

Given the often positive price reaction before inclusion, the question arises: can you build a strategy around these index securities? In theory, it sounds simple: buy the rumour, sell the news. You buy a promising index contender before the official announcement, you anticipate the price jump, and you sell at a profit around the time of the inclusion. However, in practice, this is easier said than done.

> Finding the right share and time

The biggest challenge is timing and selection. You must assess in advance which share will be added in an upcoming index review and when. Sometimes this is quite clear (for example a major entrant that meets all criteria and needs to fill a void after another index constituent's merger or bankruptcy), but all too often it is guesswork. For example, the S&P 500 is managed by a committee that makes choices on a quarterly basis and at interim events. And as the recent example of Robinhood and AppLovin shows, even experienced analysts can get it wrong (various media and banks presented these two shares as potential entrants even though they both failed to be included). If you are wrong and the stock fails to be included or is included at a much later date, you may be left with a position that (temporarily) pulls back when hope of an inclusion dissipates.

> Everyone wants to be first

Let's say that inclusion is very predictable (for example company X has recently met all the criteria and is widely expected to be added). In that case, the market will already price this in before you can take action. Professional traders and hedge funds follow potential index changes closely and will often be the first to enter, causing the price to rise well before the formal decision. By the time the average investor jumps on the bandwagon, much of the profit potential may have already gone.

> Volatility, shorters and headwinds

Shares tend to be extra volatile around an index inclusion. Both optimists and short sellers play the game. Short sellers know that an index-driven rally is often temporary, and they take short positions to benefit from a possible correction after inclusion. This dynamic can put additional pressure on the price after inclusion.

In addition, companies may announce news ahead of the inclusion that causes erratic moves on top of the index rumours. This can prompt the market to go either way – expected index constituents do not necessarily rise; if, in the meantime, the stock market crashes or the company has some bad news, this may overshadow the hype.

> No guaranteed structural return

Even if everything goes according to plan (the share is included and you sell at a profit), it is not a recipe that you can simply repeat year after year without any misses. The market's efficiency plays against it: once a pattern is known, it becomes useless. If many investors try to 'invest ahead' in index candidates, the demand for them will drive up prices prematurely, leaving less upside potential on their actual inclusion.

5. How do you know what shares are likely to be included in the index?

Although this is certainly not an exact science, there are some criteria and signs to look out for:

• Formal criteria

Each index applies eligibility rules. For the S&P 500, for instance, the following rules of thumb apply: a market value above USD 20.5 billion, four consecutive quarters of positive earnings, sufficient free float (at least 50% of the shares have to be available for public trading), and high liquidity (at least 250,000 shares traded monthly).

• Earnings trend as a trigger

Profitability is often the bottleneck for young growth companies. Tesla was only included after reporting profits for four consecutive quarters in 2020. So you need to look at companies that currently achieving consistently positive results – especially if they are big enough already in terms of market capitalisation. One example was Amazon, which had been big enough for years, but was only added to the S&P 500 in 2005 when it had achieved long-term profitability.

• Market capitalisation and index hierarchy

A practical rule of thumb: check the midcap index (S&P 400). Companies that belong to this group and are developing into a large cap are eligible for promotion to the S&P 500. For example, Tesla was in the S&P 400 for years before moving up. If a midcap is significantly larger than the smallest S&P 500 constituents and profitable, there is a real chance that it will move up sooner or later in the event of a rebalancing.

• Reasons: available room or quarterly review

Index changes often happen in response to an event: for example when an existing index company merges or goes bankrupt, this leaves a spot that is immediately filled. Coinbase, for instance, was added after Discover Financial disappeared from the stock market due to an acquisition. In such a case, analysts look at the largest available company that meets the criteria to fill the empty spot.

Then there is regular rebalancing (the S&P 500 usually presents its quarterly reviews in March, June, September and December). Speculation is at its highest around those times. This is also when merchant bank analysts publish lists of the most likely adds and drops.

• Rumours and the media

Financial media such as Bloomberg, Reuters, Barron's, etc. regularly report on possible new index constituents. Such a report can in itself affect the price. Keep an eye on these news feeds in the weeks before an index rebalancing. Social media and forums such as Reddit also discuss this topic, but make sure to take that information with a pinch of salt and to verify it through reliable sources.

Before investing, be sure to read up on the main characteristics and risks of financial instruments.

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