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Chart of the Day - the wisdom of crowds
"The four conditions that characterize wise crowds: diversity of opinion ... independence ... decentralization ... and aggregation." - James Surowiecki, "The Wisdom of Crowds"

In his 2004 book, Surowiecki states that "under the right circumstances, groups are remarkably intelligent" & it is a novel idea that crowds are smarter than individuals - very contrary to mainstream opinion

But as he states, it is also under the right conditions. I will leave it to you to discern whether those conditions exist every time we pull a crowd together to ask its' opinion

However, these conditions do exist in fincl mkts. We might argue that two broad camps - bulls & bears - is not that diverse but even within those camps there is nuance to the trajectory of growth, of inflation, of earnings, of multiples.

Almost certainly the crowd is independent. You have voices across the world & across Twitter that are all individually trying to ascertain the direction of certain markets. Yes, group think creeps in, but they come at it alone.

Is the group decentralized? Well, maybe overly simplistic but no one is sitting in the same location, working for the same company. In fact, increasingly you see more actors that may not even work full time in the business.

Finally, the aggregation. This is what fincl mkts do. They aggregate opinions very well on supply/demand, growth/inflation, earnings/multiples, taxes/debt, rates/money supply.

There are a number of measures I try to look at to assess the wisdom of crowds. One of my all-time favorites is the 20 day moving average of the Put-Call ratio of all options in the US.

When people are nervous, they buy insurance or put options. Otherwise, they are bored & sell calls against the stock they own, or get really bullish & buy calls. Watching this relative interest in puts and calls, smoothed out with a moving average, gives us information.

When the avg moves higher, it is negative for the mkt. People are nervous collectively. When it is moving lower, they are either taking off a hedge, selling a call or getting really bulled up. Either way, the nervous phase is over.

I have plotted this moving average vs. the inverse of the SPX. It does exactly what you would think. In fact, it is sending a bearish message to us right now.

Some suggest that the recent interest in 0 days to expiry (same day) options changes this. Does it? People will still collectively buy more puts when nervous and vice versa.

These 0 DTE options are now in excess of 50% of the volume in the mkt.
However, this crowd is not just naive retail money. There are institutions involved as well because there is too much uncertainty in this mkt to go out beyond a day.

Under the right conditions, groups can be remarkably intelligent.

Stay Vigilant
#markets #investing #economy2023 #stocks #options

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