Don’t confuse brains with a bull market. -Humphrey B. Neill
Spending as much time as I do on social media, namely Twitter and StockTwits, I’ve been absolutely astounded by how many traders have begun to “confuse brains with a bull market.” We joke about it on these platforms but there is an amazing amount of hubris out there right now.
One of my favorite investing quotes comes from an interview Paul Tudor Jones gave just after the financial crisis had ended:
This might be my fav PTJ quote: pic.twitter.com/3syQ3Cn4JT
— Jesse Felder (@jessefelder) April 30, 2015
Clearly, many fundamental investors were caught off guard by the crisis. Stocks they thought were cheap in 2007 got far cheaper over the coming couple of years. Being unable to “read the tape,” these investors suffered the full force of the stock market crash.
As a response to this failure, many investors have seemingly tried to adapt by becoming “tape readers.” Most notably I have seen an explosion in the number of traders calling themselves, “trend followers.”
Now I have great respect for trend-following. Some of the greatest investors on the planet are trend followers, employing a very simple yet very effective and intuitive strategy across a wide variety of markets.
That said, the problem with most of these newbie trend followers is they ignore one of the key components of the strategy: diversification. They are involved only in one asset class, the stock market. Though they respect the trend, they don’t appreciate just how exposed they are to liquidity risk right now, something experienced trend followers ameliorate by broadening out into as many uncorrelated asset classes as possible.
Emboldened by 3+ years of very low volatility, these traders have become the exact opposite of what PTJ was referring to. Their inability to understand the fundamentals, relying solely on the trend, puts them at great risk, especially in an environment of problematic liquidity.
