What Does A Crowded Trade In Stock Markets Mean?

Investment

oi-Sunil

By Sunil Fernandes

Published: Wednesday, March 11, 2015, 13:59 [IST]

It's not too difficult to understand what a crowded trade in stock market parlance would mean, since sufficient hints are provided in the name itself.

In fact, the name itself can throw sufficient light as crowded could mean following the crowds. What this means is that buying or selling into shares and following a pattern that everybody is following. The characteristics of a crowded trade would include:

A sharp surge in the share price

A crowded trade would essentially mean a sharp rally in the share price in the last few weeks. For example, during the dot com boom, share prices of tech stocks rose sharply and it was largely considered a crowded trade. Right now in India valuations of pharma and FMCG stocks have run up sharply.

Everybody is recommending the same set of stocks

You could hear analyst on TV suggesting the same stocks or same themes. Remember, this would not be restricted to stocks, but could also include industry as well.

More of short term

The trade and the ideas could be shorter or longer term trade. But, generally they are characterized by short term ideas.

Not a great trade

The short term trade may not necessarily be the best bet to get into, since they could also be stretched valuations. So, while most analyst recommend the same, there could be some that wish to exit the stock, which is why they keep recommend.

Sometimes on hopes

Sometimes the trade could be most on hopes. Say for example, many analysts could recommend buying the banking sector stocks in India on hopes that interest rates would fall. This may or may not happen, but they recommend the stocks based on hopes.

The problem with crowded trades is the exit

The problem when investing in a crowded trade is the exit. If every person looks at exiting due to a major development, the chances are we could see a sharp crash and severe erosion in prices. This is certainly not good news for those that have invested in this trade. There are many analysts who keep recommending a stock though they know that it may after all, not be worth at a higher level of valuations.

For discerning investors the best bet would be to stay away from such stocks. It's best to do a thorough fundamental analysis before investing in these shares. There's no point in following the crowds.

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