Are you following the smart or dumb money on the stock market?

Why advisors should follow quantitative data rather than their opinions, or the herd, to make the best deals

Are you following the smart or dumb money on the stock market?

Financial advisors who want to drive client success should learn how to use data to follow the smart money rather than using social trends to follow the dumb money, Keith Richards, President and Chief Portfolio Manager of ValueTrend Wealth Management, told WP.

Richards, a Barrie, Ontario Chartered Market Technician (CMT), who’s been in the financial business for 32 years, has published a book called Smart Money, Dumb Money. He’s also developed his own YouTube TV show of the same name and regularly writes a Smartbounce Blog, which you can find at his company’s website.

While he’s learned to use quantitative data and people’s behaviour patterns to his advantage as a trader, he’s also passionate about teaching others to use those skills as he looks toward the last decades of his career. 

“I’ve made lots of money and I’ve got a good business and all that wonderful stuff. We’re discretionary managers. We’re portfolio managers, not investment advisors, so we trade the stocks, and we do our platforms,” he said. “I’m now a little more interested in teaching others to utilize the tools that I’ve studied and learned how to use, so they can learn how to actually spot behavioural patterns on the markets because they’re just amazing.”

Richards began learning about things like sentiment trading, but became fascinated with human behaviour, so loves behavioural finance. He teaches advisors and investors how to look more critically at the data by sharing some of the tools he likes to use. One is checking Google Trends to see the behavioural pattern when an international word search – such as for “Tesla” or “marijuana” – peaks just before its market peaks, then falls.

“It’s a coincidental, rather than a leading, indicator,” he said. “But the peak of the word search coincides with the peak of the stock, and then the stock invariably falls within a couple of weeks of that peak search inquiry.”

There’s also a common cycle of behavioural investing patterns where people get despondent about an area, then capitulate. Richards saw the smart (institutional) money wasn’t buying much on the market in late 2019 and early 2020, while retail investors were almost euphoric then. The retail investors then became despondent when the stock market crashed at the beginning of the COVID pandemic in March 2020. By early April, the market had dropped 35%, which was the point of despondency. People capitulated, feeling “the world is coming to an end, so everybody sold stocks.” Two to three months later, it bounced back, reaching a new high above the 2019 levels.

All of that reminded him of the greater fool theory – where people will continue to buy high until the “dumbest guy out there” is the last one in, and “there are no more dummies to bid the stock up”.

“A crowded trade is what we call it when all the dummies are all over it because it’s been all over the news and they’re highly influenced people, easily swayed by the crowd. So, the crowds drive the stock up, but at some point, the elevator’s too full,” he said, “It doesn’t tell you the day or minute it’s going to crash, but it tells you the elevator is full, so it will.”

If there’s a take-away for financial advisors, Richards said it’s to abandon all uninformed opinions – of clients and themselves – and follow the data. 

“The only evidence is a series of data points that have been proven to be statistically significant,” said Richards. “It totally removes your opinion and emotion by just the quantitative analysis

“It doesn’t matter what your clients want to buy. You have to be able to tell them whether something, like Bitcoin, is quantitatively at a point where you should be buying it or it isn’t at a good point to buy, so we ought to avoid it.  So now you’ve got a piece of data that you can look at and give proper advice rather than just an opinion.

“When you look at the data, even when it’s not 100% accurate, it’s sure a hell of a lot better than an opinion,” he added. “You’ve got to be able to remove yourself from the noise and look at the data. That’s what I’m trying to teach people, so they don’t draw conclusions based on anything else because everything else is just hearsay.”