True, but what if people buy a bunch of indices, where all these jump in and jump out effects average out.

Only buying indexes is different from only buying one index.

I think the point is that index holders lose money at every jump in and out event. You can't average a list of losses to make it zero.

For example, someone willing to pay a $1 premium for an indexed stock.

It is trading at $5 today and becomes indexed, so you pay $6 for it. It leaves the index so you can only sell it for $5.

It doesn't matter how many times you average it, it is still a source of loss.

Sorry, I think you misunderstood what I meant.

If you only have one index, going from position 11 to 10 increases the value of the stock. But if you have a lot of indices, all these effects should average out to basically zero, since that stock might be in thousands of indices, and a drop out from a single index will only have a marginal effect.

I think that's correct, but it is the opposite case as the hypothetical that we are discussing. The problem with everyone index investing is that there is not an infinitely diverse pool of indices. If most people index invested into a small number of indexes, they become targets for people to exploit their predictable Behavior.

This is a long way of saying that a limited number of indices is an assumption of the hypothetical.

It would break the market if everyone invested in indexes because nobody is paying attention to fundamentals.

If there are a huge number of indexes and people are diligently picking between them, that is basically the same thing as being active investors.