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Psychology Of A Crowded Trade: GOLD

It's hard to imagine that less than 10 years ago, the precious metal which has been responsible throughout history for creating equals amount of euphoric greed as it has hopeless defeat, was essentially trading at it's cost of production.  As pointed out by Robert Prechter of The Elliot Wave Theorist in his October 2009 Issue, stories about gold during the year of 2001 could not have been more diametrically opposed to the ones we see in not only today's financial media, but everywhere.  The stories are pervasive, the greed and fear are palpable, yet what does this all mean to you and I as traders trying to make a living? Clearly, as Prechter points out, stories such as the one featured in the Barron's (yes THE Barron's) February 12, 2001 issue titled "Nobody Expects Gold Prices To Turn Up Soon", human beings who are ultimately only a medium through which electrical impulses called 'emotions' are processed and acted upon, have a horrible track record when it comes to having balanced and rational predictive abilities.  The act and though of prediction is not the issue, but instead the psychology of what it means to be human and at the same time involved with financial speculation, financial planning, or financial investment.  One cannot exist without having effect and influence upon the other.  This is a basic and elementary concept at its core, however the realities or shall we say consequences of this relationship between our actions and our emotions are much more complicated.  Why do markets move? Why do they crash and why do they explode? Humans.  Some buy more and some sell more, but it is undeniable and prove throughout history time and time again that being able to perceive market behavior from a contrarian point of view can not only be extremely lucrative, but it can save us from making impulsive and uneducated financial decisions.

Take gold for example. As of 8:00pm EST on October 22nd, 2009 the YG gold continuous futures contract was trading (give or take $3) around the $1060/ounce level.  Why? Who knows, but a lot of people believe they do know, so they have put their money where their mouth is and have purchased the precious metal lately as though it were on sale at the tick of mid-night but for three hours only! Okay, jokes aside, something is pushing gold up and it is not necessarily important what exactly that is, but instead what it means to you and I as observers (or potential participants).  I personally hate crowded trades, but then again, hate is a strong word.  We shall say that I love to hate them, but then again I live to love to hate them. They pay the bills. The hopes, fear, and greed of crowded trade participants are exactly what I seek out to capitalize on time and time again.  And what a last couple of years it has been for the trader looking to capitalize on burst bubbles.  In short script, I will not participate in them at all costs, and there exist example after example in which fantastic money and opportunity has been available to those that wait for crowded trades to unwind.  So, while I think 99% of the speculation in gold is driven by theory which could have easily been devised by your 3 year old son or daughter, it's still a crowded trade and therefore something that I will wait to pounce on until the time is right.  Each and every last sucker, er, 'believer' must be drawn into the fold.  That shiny gold, that evil US government that just prints money endlessly, that neighbor who just lost his job, the new all time high in prices per ounce.  All of it means nothing unless more and more buyers come to the table.  For prices to increase, people need to be willing to pay higher and higher prices. The inverse is true for prices to go down, and both the former and the latter are directly related to the supply and demand of buyers and sellers.  People do not want gold because they think its going to be easy to break a piece off and give it to your neighbor in exchange for some of the beautiful apples and tomatoes he grew in his 'Depression Garden", they want it because they want to MAKE MONEY.  This is where the crowd and psychology of a crowded trade come into the mix.  Markets need catalysts to continue through all time highs, higher and higher yet.  These things do not happen on their own, and just as nobody wanted to touch gold with a 10 foot pole back in 2001 (keep in mind if you had been the contrarian and bought the stinky precious metal, you would be up by close to a cool 300%), everyone wants to touch it with any pole they can get their hands on now.  Was this trade crowded in 2001 or is it crowded now? I find it amazing that so many people can come up with so many different reasons why gold is going to $1500, $2000, $3000, and even $5000 an ounce.  What are you going to do with your gold when it reaches $5000 an ounce, the Dollar Index has crashed to 40, and the government has applied 90% excessive profit taxes to any and everything that makes money in an environment that they need spendable cash as badly as the next person.  Are you going to get out your hammer and chip off a chunk of gold that "look right" in exchange for those apples and tomatoes? In the most extreme and improbable of scenarios, those that want to be holding gold now and then will most definitely need more than just gold metal because a price that high implies drastic changes to social order and the rule of law. It's asinine to even consider in my own opinion, but the guy with the most guns and ammunition will also be the guy with the most gold.  So, yes, a trade up to and beyond the all time high by a sight bit is a great opportunity to make some quick cash, anyone can see that. But by no means does this mean gold is a fundamental play in an uncrowded trade that has months if not years of going higher in its future.  This is just the opinion of one measly private trader who trades for a living in Hawaii, but nonetheless, I have seen crowded markets and the devastation they impose post-parabola.  Every parabola ends in a 'tear drop', just go look at your high school math book.  Greed, hope, and euphoria are on one side of this crowded trade, but fear, despair, and disbelief are just around the corner on the other side of this trade.  USD crashing to 40? Sorry.  The evil government finding a way to couple printed 'monies' back into spendable wages for the consumer? Sorry, again.  We cannot inflate with such rampant and runaway momentum as is the assumption in the gold trade without finding a way to couple these inflation causing permanent open market operations (POMO's) into consumable wages.  The deflationary pressures on the economy are soaking up any and every form of inflation right now, and once the retail participant realizes this, it will, as it always is, be too late to act.  This time last year oil was making all time highs, the market was trying to roll over, and gold was making all time highs.  Now, gold is making all-time highs, oil is no where close, and the market is once again trying to roll over, but in the face of both obsessively-driven fantasy growth expectations and legalized accounting-gimmickry  (don't get me started on FASB).  

Emotionally driven financial decisions are what get you in trouble, at least in my opinion.  The basis of someone's emotionally driven opinions are quite different, as long as they are not acted upon.  This is exactly how I trade, and how I maintain a strong market presence. I encourage everyone to do the same, and while it is impossible for markets to operate with everyone in agreement, I promise that it will serve you well to make note of crowded trades dominated by public opinion.  See them, plan your action, and just be patient.  

The only guarantee in trading is that when every last buyer who is able and willing to buy has in fact bought, the only place to go is down, it just takes time.  Reward yourself by being patient, and you will not only have a strong market presence, but you will understand your own psychology as it relates to the crowd, and most importantly you will make money! The loser is out there, he/she just must be located in the market. Crowded trades are great places to look, and with enough practice, you will always know how to react!

Good Luck!