Too Many People On The Same Side Of The Trade? The Market Is Teetering On Record Margin Debt, Fundamentals Are Deteriorating, Interest Rate Cuts Fail To Spur Growth… Could Major Players Make A Big Fortune By Simply Going Short Here?
May 10th, 2013
When Everyone is On the Same Side of a Trade, the Market is About to Crash
Economist Blake LeBaron has discovered an important cause of stock market crashes:
During the run-up to a crash, population diversity falls. Agents begin using very similar trading strategies as their common good performance is reinforced. This makes the population very brittle…
In other words, when everyone is making the same trade, it will likely lead to a crash.
Tyler Durden summarizes this idea even more succinctly:
When everyone is on the same side of the boat, it always inevitably capsizes.
A related concept is that – if your waitress or cabbie is telling you to buy something – that probably means that the market is overbought, and you might want to consider selling.