Sizing Up Your Fellow Traders in a Crash

Dynamic Hedge blogs about correlation, relative value and quantitative analysis at http://www.dynamichedge.com

The worst part of trading in a small office filled with good traders, is you don’t have any good tells on crash days. When I traded in a larger office with more 20 or more guys, days like this were easier.  You’d just watch the Urkels. Let me explain. When the market is crashing, you basically have to throw every indicator or fundamental piece of data, save short interest and debt ratios, out the window. The market is running on pure emotion. The only thing that can help you time your trades is focusing on the sentiment of those around you. The only clue of a potential change in market direction comes from watching real-time capitulation of those with skin in the game. Shitty, I know, but true.

Some key observations:

1) You have to identify the loudest and most emotional dudes in the room and totally tune them out. They’re going to freak out regardless of what happens. They’re just noise. You want to focus on the calm and collected guys and who can usually keep it together emotionally, but tend to have bigger intraday swings in their account.

2) The tone of the room before the market opens is key. Everyone can see the headlines and where the futures are trading. The guys who came in super long might be trying to talk themselves into a snap back rally, or a hypothetical short squeeze. Keep in mind that they’re running these narratives in their head as the market is actively selling off. Take this as a cue to lighten up your positions immediately. When guys are staring into the abyss and trying to talk themselves into toughing it out, and will soon be puking them up.

3) Some guys may have come into the room short. They’ll be very happy — giddy even. Short sellers are used to being nervous about the whole world trying to screw them out of their profits. When they start to win on an industrial scale they get super cocky. Pay attention to the overall level of swagger. When they go full Kenny Powers, you might be getting close to a bottom.

4) Focus on the breathing, the heavy signs, the groans, and the cursing coming from the longs. Especially those who added to positions, or doubled down. The general chorus of emotional noises associated with losing money will begin to harmonize with the ebb and flow of the S&P 500 index. Notice how loud it is as you make new lows and how silent and anticipatory it becomes when the market rallies.

5) When the groans give way to a series of, “F**K IT, I’m out!” This is called the pinch point (official terminology). The pinch point often happens for several guys all at once as they all sell down to flat or personal level of comfort. This is such a great relief for them, but it also means that the market should be bottoming out any second. For real this time. Consider adding back the positions you lightened up on.

6) If you stop hearing noise from your colleges consider walking up to a trader staring intently at his monitors. Nonchalantly mention that you came in flat today and have no interest in trading this “crazy” market. Tell him you’re going to get a coffee and offer to grab him one. If he snaps and curses at you loudly, you may be getting close to a bottom. Or you may just be getting what you deserve for being a dick. If he throws a monitor at you; it’s probably time to buy.

7) This process can last for days. There will even be times when the silent anticipation on market rallies gives way to high fiving and grandstanding because, “I’m so lucky I didn’t get shaken out.” Don’t worry, everyone finds their pinch point eventually.

Remember, in a crash situation, the market isn’t waiting for buyers to come in, it’s waiting for sellers to run out. Very few want to buy in a panic. Only after everyone is done selling and the strongest hands remain can the market start to work higher.

If you think it’s morally wrong to use others as a sentiment indicator just remember they’re doing the same thing to you. The sounds and body language of others is the only indicator available to you in times of market dislocation. Use it. If you find yourself on the other side of a capitulation tell, and some other schmuck makes a mint off your misfortune, don’t get mad at him. Your time will come.

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