This Crowded Trade Is Running Out of Steam

This essay was originally published in DailyWealth Trader, a daily trading advisory, and has been adapted. To learn more about this service, click here.

Bullish bets are stacking up in one area of the market. And it's not where you'd expect...

I'm not talking about major tech stocks or artificial-intelligence plays. Instead, bets on a certain asset just hit their highest levels in more than 15 years. They've only been higher one other time in history.

This crowded trade is pushing the limits of how "loved" an asset can get. And when the trend turns, sentiment could propel this asset in the other direction.

So, while this investment likely isn't on your radar, it's a market you should keep a close eye on right now.

Let me explain...

Understanding the crowd is one of the most important factors in investing. If a crowd forms in the market, it's often on the wrong side of the trade. Those who can spot the crowd at extremes give themselves an edge over other investors.

Some of the best sentiment measures come from the Commitment of Traders ("COT") reports. These reports cover what futures traders are doing in bonds, stocks, currencies, commodities, and more.

Specifically, we want to watch the speculators in these markets. These traders often try to make a quick gain in the market. But they tend to get the timing wrong.

When the speculators are all betting in one direction, you typically want to do the opposite... because when they're all acting on extreme greed or fear, they tend to make terrible trades.

That's what's happening right now in the British pound.

The British pound has been rallying against the U.S. dollar for most of 2023. This "boring" currency is up 21% in less than a year. That's a massive move for a developed currency.

You see, major currencies tend to move glacially. A 5% move in either direction in a year is a pretty big swing. So that makes the 21% move even more impressive.

Now, speculators are finally going all in on the British pound. But the thing is, they're late. They're chasing last year's rally...

Bullish bets on the British pound are at their highest levels since 2007. We've seen similar cases a handful of times over the past 20 years. And they tend to be warning signs.

This trade is running out of steam. Take a look at the previous sentiment extremes like this one... in 2007, 2014, 2018, and 2021. Each case led to major declines in the British pound.

In 2007, the currency climbed for a few months before peaking. And then it tanked to 1.38 by early 2009. That's a 34.5% crash in less than two years – and also the most extreme case. But 2014 wasn't much prettier...

Speculators were going all in on this currency in early 2014. It traded at roughly 1.72 in July 2014. And it fell to 1.21 by October 2016. That's a 29.7% fall in two years.

You can rinse and repeat this pattern for 2018 and 2021. Speculators went all in on a higher British pound. Then, the currency fell double digits over a year or more.

In short, this currency could climb for a few more months before turning lower. But when it does swing to the downside, a multiyear fall is likely.

Overall, the crowd is falling in love with the British pound. That means a reversal is likely to happen sooner rather than later. And once it does, history shows the new trend will last for months... possibly years.

Good investing,

Chris Igou

Further Reading

"When bullish sentiment hits these ultra-high levels, it's nearly impossible for prices to keep soaring," Brett Eversole explains. Traders recently crowded into one commodity. But following them today would be a mistake... Read more here.

Contrarian trading can give you a huge advantage as an individual investor. Professionals often don't have as much freedom to go against the crowd. And if you learn to do it the smart way, it can be a road to outsized gains... Learn more here.