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Risk Management

The Perils Of Taking Market Advice From A Counterparty

Many retail traders and investors cannot wait to read the next social media post or article from their favorite fund manager because they think this way they will gain a market edge. On the contrary, in many cases, they are set to lose.

Pros understand the game well because it is their job. They have survived long to know what it takes to profit.

Especially during uncertain markets, pros know well that profits come from the pockets of losers. For everyone else other than long-term passive investors, the game is zero-sum: there is no way for some market participants to profit unless some other participants lose. The exchanges when they settle transactions will always redistribute the losses to the winners. This is how markets work.

The fund managers, CTAs, etc., know well these facts. A few years ago, the CIO of a fund argued that “trend-following and other pedestrian quant strategies, such as momentum, won’t survive due to lack of dumb money.”

There was a huge influx of money due to the pandemic stimulus. No one could have predicted this. Hundreds of thousands of new retail traders used their stimulus checks to trade quick-rich schemes and hopes and dreams (options). That offered oxygen to the fund industry as their profits mostly come from uninformed retail.

Someone would ask: how can CTAs benefit from retail trading mostly stocks and ETFs? As I argued in a recent Twitter Space of legend CTA Jerry Parker, this is due to financialization and ETPs. There is a long list of ETFs based on futures. When a retail trader buys shares or options of these products, there is proportional action in the futures markets. For example, the United States Oil Fund LP (USO), primarily invests in futures.

These new products have caused the financialization of commodities and have also made up for some of the lost retail pool of the 70s and 80s that enabled CTAs to make huge profits. Before the 90s and the dot com frenzy, trading was synonymous with futures trading. As the retail futures traders’ pool size plunged due to zero-sum game wealth transfer to CTAs, a new pool emerged in the equities market.

A similar mechanism of wealth transfer is present in equities markets. For large AUM funds to turn unrealized gains into realized, there must be a large pool of retail liquidity. If the retail liquidity is not there, markets become unstable, and funds profit only if other funds lose. This occasionally happens with the closing of funds due to large losses.

The methods pros use are complex and a lot depend on sophisticated risk and money management. They rarely talk about the specifics of their models but many are willing to talk about market direction. Some of those that were permabears after the GFC bottom are still around. What people say and what they do could be two different things. As long as they do not advise anyone personally, on social media they can hide behind a general disclaimer on their profile. If they are still around and especially if their AUM and profitability have grown, then they were probably searching for liquidity when they were making those permabear calls.

In my opinion, perceiving views of pros as market advice entails high risks. Not only they may be trading in the opposite direction, as their disclaimer makes clear they can, but they can change their mind the next day and are not obliged in any way to inform anyone.

Unless someone knows the details of their trading or investing process, following those smart people is an exercise in futility. There are two choices for retail:

  • Develop a process.
  • Let a certified pro handle it.

For most people, the only feasible solution is to have a certified pro invest or trade for them. In this way, indirectly the customer becomes part of the games people play on social and financial media but in their favor.

Adding a famous fund manager or CTA to a social media list and expecting to make money by following their market views could turn into a disappointing endeavor.

They may not be out to help anyone to profit but if possible to profit from them, unless they are the customer, in which case they profit by charging fees.

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Disclaimer:  No part of the analysis in this blog constitutes a trade recommendation. The past performance of any trading system or methodology is not necessarily indicative of future results. Read the full disclaimer here.