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This is not true! A really basic cap-weighted index fund mechanic is that they automatically track the index as prices move, with no trading required. This is literally the reason that they are called *passive* funds.
For some reason this breaks people’s intuitions and they get really excited about forced buying/selling from passive funds creating positive/negative feedback loops, which, I cannot emphasise enough, is not a thing that actually happens except in retail brain fantasies.
Index funds do need to trade, but only on a few specific events - mainly index adds/deletes and corporate actions (e.g. new issuance, buybacks, mergers and acquisitions).
There’s a whole exciting thread about *index rebalance* trades which I hope to write about one day but that is entirely separate to the day to say mechanics of index fund management, which is largely very boring and consists of making sure you are correctly
tracking corporate actions for the index constituents. Fin.
An important addendum is that index funds also trade when they have inflows and outflows (or an AP trades on behalf of an ETF using the create/redeem mechanism). This is important but orthogonal to the main point, which is that index funds basically never trade on price alone
I just realized that @bauhiniacapital wrote about this way more eloquently and also ~5 hours earlier here —https://twitter.com/bauhiniacapital/status/1359919232062873603 …
This thread is a great example of the incredible broken brain gymnastics that people will perform to to misunderstand how index funds work and how they impact prices. Not matter how hard I try to explain it, he keeps repeating the same meaningless point I give up! https://twitter.com/whirlybard/status/1360334892236607489 …
Muddy Waters just wrote a thing about this implying "1929-1931" levels of drop with 2020 swiftness would be the result of this supposed forced selling
.@alexharfouche1 please explain why you are thinking different? How does the price of the stock going down not automatically balance the fund for the drop of the weight of the stock in the indexhttps://twitter.com/alexharfouche1/status/1359902546714836994 …
So this makes sense on the way *up*, as more of every $ is going into a stock w/ a shrinking float. But on the way down, assuming a market rout where investors are panic selling out of passive funds, it's less of every $ coming out of a growing float, no?https://twitter.com/profplum99/status/1359843654731370500 …
The problem is that it's not just retail brain fantasies.
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