InvestorQ : How do I identify overcrowded trades and get out in time?
Ria Jain made post

How do I identify overcrowded trades and get out in time?

3 years ago

The joke in the market is that overcrowded trades when your lift boy and cab driver start giving you that tip. At the height of the technology boom in 2000, it was common for office boys and lift men in South Mumbai to keep talking about SSI and Himachal. We all know what happened to these stocks subsequently. How do we handle overcrowded trades?

Firstly, try to be an early bird into any trade. For example, when the Gujarat elections concluded, it was quite obvious that the government would give the budget a rural twist. But the market started recognizing that only later on. The right time to take that trade would have been immediately after the election TV polls predicted a close election. You would have had a lot of money on the table. Once the expectations were built across the street, the trade just became too overcrowded.

Trading and investing is not just about the obvious. Quite often, the big beneficiaries are the corollaries. When smart phones were introduced, FinTech got a big boost. That is where most of the money was made. Look at lateral beneficiaries. This is slightly more complicated. Take the case of Levi Strauss. During the Gold Rush in the US, Levi Strauss realized that irrespective of whether prospectors found or gold or not, they will still require rough jeans to help them in the activity. That is how Levi Strauss & Co. was born and it is a classical example of thinking laterally for opportunities.

Trade a little more cautiously and smartly. Don’t jump into an overcrowded trade. Once you are convinced about the worth of a trade, wait in the sidelines if you feel that the froth is too much. The moment the market corrects, you will get an opportunity to by these same stocks at more reasonable levels. That is the right time to enter.

When you get a trigger, don’t look for the obvious outcomes. Look for the more subtle outcomes. These are the ones that are less obvious. Once the trend is clear you must look for the not-so obvious answers. When the budget announced the National Health Program, most trades missed out the fact that diagnostic centres and insurance companies could be big beneficiaries. Most of these stocks showed a very strong traction in the coming weeks and held on to their gains despite the vagaries of the market. Try and focus on the less obvious stories.

If you have the gumption, try to take the contra trade on an event. Take the case of the Union Budget 2018. Most traders saw the positive trade on rural consumption. What you missed out was that the higher fiscal deficit would push up yields and that will leave a big hole in bank balance sheets in terms of investment loss provisions. That story is really playing out now, although there are other factors too at play.

In any trend, the institutions are the first and the retail investors are the last. See where the crowding is coming from. Always try to assess who is crowding into any trade. Normally, we find the institutions and HNIs being the first to enter the trade. The retail investors tend to follow after that and that means they actually help in the distribution. Remember, nobody makes money when stocks are getting distributed. Try to run on the coat tails of the institutional approach to trades. That is a much better lead indicator of prospects ahead!