Market Crowd Factor: Why Trend Might Not Be Your Friend Sometimes
Although a successful stock market investing or trading is complicated, in general, it consists of three major parts: analyzing data and possible future, making decision, and executing this decision. The same applies in case of automated trading - just these parts incorporated in the system and work in the same way. If we abstract from non-controllable external factors, we could clearly see that the quality of our decision and consequently the outcome depend on input data and their processing to make an optimal decision. What input data are the best and how to convert them into a a meaningful information and finally into a right action?
Quality vs. quantity. First of all, apparently, too many data, especially, that are non-relevant to the searching result, might make the solution too noisy and with error ranges that exceed the accuracy of a certain solution. That is why most market participants use a limited but sufficient enough the set of input data in order to transform it further into a necessary information with a minimal uncertainty. The second important task is a processing with the highest quality of extracting worthy information. A good processing enables enriching the information while trying to avoid losing any value in the translation process.
Sometimes quantity can be good - trend might be your friend. Is it possible to find and use the best universal principles and systems in stock trading? The second question - is it possible to make money using methods, systems, or ideas that are employed by many? It seems collective actions can be beneficial. For instance, if there is an uptrend - many would join the movement and add more pushing power up. Although a crowd behavior could be useful, sometimes, it can lead to unexpected results.
What if everyone expects the same. Typical example - many thought that February could be a good month to invest because institutional funds' managers could increase their portfolios in March. Many converted cash into stocks in February pushing market up. Then when buying power exhausted and funds were unable to support the trend - the stock market collapsed. Another examples, several years ago October was a low month but since too many talked about this annual cycle, it is not the case anymore - everybody buys in October and pushes the market higher.
One more example is a classical double top or bottom - now it has almost disappeared from charts. It happened because many started to exploit this idea to their benefits. For example, when the market while correcting headed to a previous low, everyone waits if it bounces back or breaks down. If almost everyone is considering that it is not good time yet to sell (or go short) and waiting for this magic level, this move might not happen. The reason is that there will be no sellers but mostly holders that are waiting. It is a situation when the same expectation of many affects the market.
The danger of crowd. Some classical books warn investors - when everyone is very bullish in the stock market - this is time when the market can crush because there is no one left who can invest more money to support the uptrend. It was in case of a hi-tech bubble in 2000. What factors influence our investing or trading decision? The opinion of most market participants? But their opinions link to their actions - that is why a trend might be built on sands and it can let you down anytime.
The benefit of using a new or rare approach. Let's imagine the situation - a group of people read the same book, for example, "How to Find Mushrooms" and all go to one forest. Evidently, then there would be more chances to find mushrooms in the places that are not recommended in this book. Why some people still argue if the stock market now is the same or it is different? - maybe because they cannot distinguish the things that remain always the same and the things that are changing at different paces depending on their internal nature and changing external factors. The conclusion - stock trading can be successful also in case of using something new or something that is used by limited number of traders.