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Front-Running the Crash

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What if everyone in the market realizes it’s now the moment to front-run the crash?

We have a fine-sounding word for running with the herd: momentum. When the herd is running, those who buy what the herd is buying and sell what the herd is selling are trading momentum, which sounds so much more professional and high-brow than the noisy, dusty image of large mammals (and their trading machines) mindlessly running with the herd.

We also have a fine-sounding phrase for anticipating where the herd is running: front-running. So when the herd is running into stocks, those who buy stocks just ahead of the herd are front-running the market.

When the Federal Reserve announces that’s it’s going to make billionaires even wealthier with some new financial spew, those betting that stocks will never go down because the Fed has our back are front-running the Fed.

There are two remarkable assumptions at the heart of momentum and front-running:The momentum herd and those front-running the herd base their behavior on the assumption that there will always be other rich people who will sell all the shares they want to buy at today’s prices before the run-up to new highs.

Since only rich people own stocks, we know that those selling stocks are selling to other rich people and those buying stocks are buying from other rich people. So the assumption of those front-running the market is that there is a large enough sub-herd of rich people who for whatever reason aren’t smart enough to front-run the herd, and who will foolishly sell their stocks just before they double in value.

The second assumption is that there will also be a large enough sub-herd of rich people who will buy all the shares they want to sell at the top, just before the bubble pops and the value of the newly purchased shares falls in half.

There are various ways to state this, but the bottom line is that momentum and front-running are only profitable if you sell at the top, just before the bubble bursts.You would be forgiven for anticipating that the same sub-herd front-running the herd and the Fed on the way up to the top of the bubble would be just as prescient and active in front-running the inevitable bursting of the bubble, but this is not how running with the herd works.

Short interest recently plumbed multi-year lows, indicating that very few are front-running the market crash.

Those trading momentum and front-running the herd/Fed are making a remarkable assumption, an assumption which is visible in a great volume of financial-media content: the stock market, we’re told, will continue to make new highs like clockwork until some point in the third or fourth quarter, at which point there may well be a spot of bother, i.e., a crash.

The assumption is that all the rich people who own stocks will be so splendidly stupid that they will hold their shares until the crash and then sell them at prices far lower than they can fetch today. Put another way, the market participants who decide this is close enough to the top to liquidate their positions today and not wait around for the crash to wipe them out assume that that the herd of other rich people who will be delighted to buy their insanely overvalued shares at today’s prices is large enough to absorb all their selling with no downward pressure on valuations.

In other words, the assumption being made is: I can wait until just before the crash to sell, because there will be boatloads of splendidly stupid rich people who will buy all the shares I want to sell at today’s lofty prices–or higher, and this liquidation won’t push valuations off a cliff.

As a general rule, people don’t all become rich by being splendidly stupid, i.e., failing to anticipate what other rich people are about to do, and so this raises the question: what if everyone in the market realizes it’s now the moment to front-run the crash?

Perhaps Wile E. Coyote could offer some useful perspective on what happens next.

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Source: http://charleshughsmith.blogspot.com/2021/06/front-running-crash.html


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