Sunday, June 24, 2012

Crowded trades - need to avoid

"As a general rule, it is foolish to do just what other people are doing, because there are almost sure to be too many people doing the same thing."  -William Stanley Jevons


"I find more and more that its is well to be on the side of the minority, since it is always the more intelligent." -Goethe


"Doubt all before you believe anything! Watch your idols!" - Francis Bacon


"Follow the course opposite to custom and you will almost always do well" - Rousseau 


"When everyone ignores a vital subject, it is likely to be important to everybody" - Neill


"Invention and imitation are motivated by belief and desire" - Tarde 

I have been spending more time thinking about crowded trade. The trade may be the right one to place but being crowded creates a different level of risk than with other trades. Crowded trades also mean that there is less thinking about what may go wrong. When this happens, there is a greater likelihood that when the crowd changes, there will a significant adjustment in the market. 

Crowded trades are also difficult because they are more likely to be adjusted when there is a switch between risk-on and risk-off environments. When there is more risk placed with a certain type of trade, there is also more likelihood that the risk capital will be reversed at critical times. 

Still, the most important issue is determining what is a crowded traded. These are the trades that become popular. There is nothing wrong with being popular except when it becomes "too popular" and this is the issue that is hard to measure. Crowded or popular trades are like momentum. Anyone would like to be in momentum trades but need to determine when to get out. A measure of polarity would be nice but i leave that for more work.

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