InvestorQ : Are all low hanging fruits going to result in losses?
Ria Jain made post

Are all low hanging fruits going to result in losses?

Khushi Patel answered.
3 years ago

Maybe not always, but it is hard to make money out of low hanging fruits. Generally, they have negative economic payoffs. What exactly do we understand by negative economic payoffs? When we talk of an equity trade, we are referring to the valuations getting quite rich well in advance. When we are talking about buying calls and puts, we are referring to the time value of these options becoming high enough to dissuade any profitable buying in the market. In case of futures, the premium over the spot price almost makes the trade prohibitive and in case of options, the premiums become just too steep.

Why do crowded trades create negative payoffs? Crowded trades create negative economic payoffs due to 3 reasons. Firstly, the demand for these trades far exceeds the supply. Hence the cost of these trades goes up substantially as we saw in the case of rural stocks. Secondly, the trade becomes skewed since most traders and investors are trying to play the trade on the same side and there is an absence of any counter trade on these stories. Quite often you find that there are only buyers for a trade and very few sellers. That gives an illusion of the trade creating value which is not the case. Lastly, a combination of round-the-clock media debates and analyst notes hardly leave any surprise element. That literally takes away the alpha trade and leaves it with negative economic payoff. With the internet, live news, Twitter handles and WhatsApp sharing; most of the cream is out of the obvious traders before you even realize it. Hence don’t count on them at all! If you want to make money as a trader then you must have the ability to buy on rumours and sell on news announcements”. That is when it works best but it is a huge risk nevertheless.