Technical Analysis: How to Recognize a Crowded Trade
Crowding the wrong side of the trade is the worst thing any one can do.
All of a sudden, every one and their 80-year-old grandmother are piling money into a trade, thinking some one must know something they don’t. Instead, what’s happening is they’re getting caught up in herd mentality.
The same thing happens to hedge funds more times than imaginable.
The only thing it’s good at doing is losing you money.
For example, in April 2015, hedge funds crowded into their largest bets on oil, as prices began to rally back to $60 a barrel. Data showed that hedge funds and large speculators had accumulated nearly 265 million barrels of oil – the equivalent of three days of global oil demand. A great number of hedge funds crowded the bullish side of the bet.
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For some, like Pierre Andurand, a French energy hedge fund manager in London, as quote by FT.com, noted, “For me I still think we need to go a lot lower.”
Shortly after, oil prices would sink to less than $40, then to $26.05. Did they learn anything from that? No, of course not. They still continued to crowd trades and lose money. In February 2017, they pulled the same garbage, and are so far, losing good deal of money.
Even with record crude and gasoline supplies as well as stronger U.S. oil production, hedge funds boosted their net long positions to more than a billion barrels of crude. They were betting the OPEC supply cuts would be enough to balance out the markets. What we were seeing at that time was the crowded trade phenomenon that could force oil even lower from here.
At the moment, oil prices are plunging to a three-month low because we’re still seeing a bigger than expected increase in crude inventory. That’s not good for oil prices or the hedge funds that have crowded the wrong side of the trade.
Technically, oil prices were finding heavy resistance just under $55. Downside appeared to be capped around $52.30. But given the weakened fundamentals of the oil story, oil prices just broke to $50.34. Should the fundamentals fail to improve, near-term, oil could sink to double bottom support just under $45 a share, worst-case scenario.
That could easily happen, as prices are on track to break through the key psychological level of $50 after another crude build and the fact that U.S. production is ticking back up to 9.1 million barrels a day, a one-year high. OPEC agreement or not, oil could be a technical disaster.
For the hedge funds to make this much of a mess with such a sizable bet, with a full understanding of true fundamentals here is embarrassing. Lesson learned – if you do what every is doing in a crowded room, you stand to lose.