Index Rebalancing
Index rebalancing is the periodic adjustment of an index's members and weights to bring it back in line with its rules.
Every stock market index follows a set of rules about which companies it includes and how much weight each one gets. Over time, prices move, companies grow or shrink, merge or are delisted, and the index drifts away from its rules. Rebalancing is the process of correcting that.
There are two related activities. Reconstitution changes the list of members, adding companies that now qualify and removing those that no longer do. Rebalancing in the narrower sense adjusts the weights of existing members, for example to restore caps on the largest stocks or to reset equal weights. Many indices do this on a fixed schedule, such as quarterly or annually, and also make changes when special events occur.
Index providers announce changes in advance. Because index funds and ETFs must buy and sell to match the new composition, rebalancing days can bring very high trading volume, especially at the market close. Stocks being added to a major index often rise on the announcement, though the effect varies.
Example: a company grows large enough to be added to the S&P 500. Funds tracking the index must buy its shares on the effective date, while the stock it replaces is sold.