There is a saying on Wall Street that the markets try to deliver the maximum amount of punishment for the most investors possible. They call this phenomenon the “pain trade”.
In essence, the pain trade is when investors become so overly bullish about a specific theme or outcome that they overload one side of the boat. As the boat leans further to one side, the majority of participants become complacent as their thesis bears fruit. This leads to a heightened level of pain as the equilibrium shifts and the boat tips back to flat or in the opposite direction. The shifts usually happen in a very short period of time and with little warning, which makes them difficult to predict and re-position ahead of time.
In bull markets, the pain trade is typically lower. In bear markets, the pain trade is typically higher.
Right now, I believe that the trade that will cause the maximum amount of pain for the most investors is for stocks to march higher. Let me explain what I mean by that…
In January I was having a conversation with a friend of mine that is a really sharp trader. He asked me the question that is usually on most people’s mind at the start of the year – Where do you think the market will end 2016?
At the time, we were about 10% off the highs and sentiment was in the dumps. Just about everyone in the main stream media, social media, etc. had declared this to be a pernicious bear market. So my response caught him off guard when I said that I would not be surprised if the market finishes the year positive.
I can visualize the look on your face right now as you read that. The first thought going through your mind is probably “are you fu%^&ng kidding me? There is no way that can happen.”
Follow-on thoughts likely take the shape of:
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