Trading is a very competitive business. There are so many different types of market participants; pension funds, institutional investors, momentum funds, hedge funds, algorithmic traders, day traders, prop traders, and retail traders are all competing against each other to succeed.

For me to ensure my trades go according to plan, I don’t just trade chart patterns or moving average crossovers. That is not enough for me. I try to understand where the majority of these market participants may be positioned in any particular stock. 

Understanding market sentiment helps me find unique opportunities to bet against the crowd. Today we will discuss how to do just that.

Why Market Sentiment is Important

I read a lot to understand what is happening in the economy, the business climate, and the world. I use Twitter and Reddit to get a feel for sentiment and hot market stocks. I try to understand the story behind what’s going on and where certain players are positioned.

I do this because I understand there are large institutions out there with billions of dollars who employ hundreds of people with Ph.D. s looking for and creating algorithms with an edge. A lot of these quants are behind short term momentum and they are also looking at market sentiment to understand where retail traders may be positioned.

These algorithms understand where the pain points are for traders, where their stops may be, and what will move prices to shake retail traders out of positions. When a trade is crowded, funds who pay millions for this broker data will look for blood.

This will happen whether a trade is short-crowded for example TSLA, GME, AMC, or long-crowded, for example certain SPACs such as FSR or CLOV. So, I try to understand the sentiment of who may be positioned where to understand what the smart money and market makers may do going forward.

Retail traders and Wall Street Bets Apes have dreams of Lambos and yachts but with no real trading strategy except for “hold the line” and “short squeeze.” When the time is right and my setup is there, I want to make trades that go according to my plan, fading these pipe dreams because I know the market is serious business and will crush unprepared market participants.

Roblox Setup

Roblox (RBLX) was a hot IPO from back in March 2021. It is a platform that allows users to explore 3D digital worlds and allows developers to create, build, publish and operate 3D experiences. The platform grew users a lot during the lockdown, and even my kids played it.

The hype around it on social media was immense, and there was a nice opportunity on the long side post the IPO from $60-$80 to $100 but when this stock failed at $100, I was aware that there may be an opportunity to the short side setting up.

Having failed to hold above $100, RBLX found support at $80 in late June. But coming into July, it had made a lower high at $93 and was consolidating in the $86 area. I prefer to trade the chart, not the news.

I was aware that this is a very hyped stock. A lot of traders bought the dip above $80, hoping this stock would bust through $100 and go to the moon. RBLX is a known investment of Cathie Wood of TSLA fame in her fund ArkInvest. Rather than listen to the hype, I prefer to listen to what the market is telling me.

The last couple of weeks, small-cap tech stocks were doing terrible, I knew this because I was in some of them. While QQQs and large-cap stocks were marching higher, the smaller-cap stocks were selling off. I was also expecting some market jitters due to the Covid-19 Delta variant. Putting all of these things into context RBLX had set up perfectly for a short.

There was so much bullish market sentiment about the stock. But the chart was telling me something different, it failed at $100, it failed at $93 and now was holding at $86 below the VWAP from the highs. When there is overwhelming bullish market sentiment in a stock that is not necessarily a good thing for very long, I prefer to fade these types of situations. 

As we can see, once RBLX failed to get above $90 and broke below $85, that was all she wrote. There was prior support at $80, and we broke through that, presumably stopping out a lot of traders for a move to $76. This is a perfect example of fading sentiment and listening to the chart.

I spoke about this trade in the Master’s Club last week. Unfortunately, my working order to sell a call spread did not get filled. I stayed disciplined and didn’t chase the stock. It was a missed trade, but the logic was correct. This is the type of thinking required by professional traders. 

Bottom Line

Thinking like a professional trader is important to be prepared for trading setups. This is why I try to understand market sentiment in a particular stock or the market as a whole. Overwhelming market sentiment one way in a stock is not necessarily a good thing for very long. 

Understanding that large funds also trade around this concept with their algorithms, I try to fade overwhelming market sentiment when this particular trade sets up. I want to understand where the majority of participants in a stock are wrong and use this intuition and information to be ready for great trade setups. Hope is not a trading strategy.

Jeff Bishop

One of the best traders anywhere, over the past 20 years Jeff’s made multi-millions trading stocks, ETFs, and options. He is renowned as an incredible trader with a deep insight and a sensitive pulse on the markets and the economy. Jeff Bishop is CEO and Co-Founder of RagingBull.com.

Even greater than his prowess as a trader is his skill and passion in teaching others how to trade and rake in profits while managing risk.

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