Crowd trading is a fundamentally new and revolutionary trading strategy that is fast gaining in popularity. Often dubbed as the ‘Wisdom of the Crowd’, it is a technique that uses the decisions taken by the majority of the crowd (investors) to understand a market trend.
A crowd consists of traders with various levels of information and sophistication. They can be investors working from the comfort of their home or expert individuals working for a trading desk.
A trader has bias and emotions that can affect decisions. However, the opinion of the crowd removes those elements and filters out the useful information for traders. It can then be used to understand price movements and market trends.
Why trade the crowd?
Academic research supports the efficacy of crowd trading. A paper published in the International Review of Economics and Finance in 2019 found that using consensus to trade resulted in a monthly excess return of 3.3%. The report, titled ‘Swarm Intelligence? Stock Opinions of the Crowd and Stock Returns’, explained that the crowd contains information that can help with making rewarding investment decisions.
Another paper examines how crowdsourced financial estimates help to generate active returns in the financial markets. This study examined crowdsourced earnings and revenue forecasts and found that the crowdsourced estimates are more accurate than those of Wall Street. The paper finally demonstrates that a strategy exploiting the variations between the Wall Street estimates and crowdsourced ones, earns positive returns, especially with large-cap stocks.
The intuition behind crowd trading
In reality, traders have always used crowd information for trading. Think of a time when you have discussed a stock with your friends and colleagues — in essence, this is an example of receiving feedback from a ‘crowd’. The difficulty with that approach is that the feedback comes from a limited number of people, who are likely to have the same social or educational background as you.
Yahoo Finance message boards are another example of a crowd sharing information. It cannot be used for live trading, however, due to the lack of a real-time and a concise information signal.
Historically, access to live trading information has been limited. Even though online trading has eased the retail participation in the financial markets, accessing live information about the crowd was not possible until recently. Now, some online brokers provide access to trading based on crowd information.
Conclusion
Crowd trading is not a magic wand nor a solution to all trading woes. A thorough understanding of the fundamentals of trading is still required to take full advantage of the information.
The crowd-based signals provide a trader with additional indicators of where a stock or the market is heading. The information is highly relevant and helpful to traders that understand the fundamentals. Crowd signals, such as sentiment and real-time event information, are innovative tools. When added to the arsenal of a trader, they can improve trading decisions and profits.
