What is contrarian investing? – Forbes Advisor
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Opposites go against the grain: if you say high, they say low. Contrarian investing is choosing to put your money in assets that go against market sentiment. When the stock market sells off, contrarian investors rush in and buy, or they sell when there is a wave of buying.
What is contrarian investing?
The herd mentality almost always prevails in the financial markets. Most market participants share the general consensus that the stock market is doing well and should continue to rack up gains, or that the market is struggling and will be lower next week than it is today. .
Contrarian investing means having a view of the market that is not appreciated, then doing the necessary research to determine if there is an investment opportunity. Successful contrarian investors must be willing to spend a lot of time assessing market conditions to build their case.
If the prevailing market sentiment is that the pace of economic growth will accelerate, for example, by further stimulating market gains, an opponent might decide to make investments based on the idea that the economy will only accelerate not and stock prices will go down.
The concept was best summed up by famous contrarian investor Warren Buffett when he said, “Be afraid when others are greedy, and greedy when others are afraid.
It can take weeks or months for an investor to fully develop a contrary view, and even longer for their strategy to bear fruit. Contrarian investors need to be comfortable with the risks and potential losses that come with the wait. By making investment decisions that align with a contrarian view—and doing it early—contrarians aim to make trades before the consensus turns in their favor.
How does contrarian investing work?
The starting point of contrarian investing is to fully understand the consensus view. This can be for an individual stock, a broader stock industry, or the market as a whole. Then, a contrarian investor pokes holes in the consensus and develops an argument that underscores their contrarian point of view.
For example, if the consensus view is a “bull case” for the stock market based on accelerating economic growth, a contrarian investor could create a “down case” for the market as a whole, or sectors within it.
A contrarian investor can also end up bullish when the prevailing sentiment is bearish. This is especially true for individual stocks or sectors of stocks that have fallen out of favor. Hedge funds, which pool investors’ money, often seek aggressive contrarian investment strategies, for example.
Contrarian investors are not looking for short-term gains. The goal is to identify pockets of opportunity within the market where they believe the consensus view is wrong, in the hope that their investment will pay off as other investors readjust their outlook.
As a result, contrarian investors need to be comfortable with short-term losses and the uncertainty that comes with waiting for confirmation of their contrarian view.
Contrarian investing vs other investment strategies
Contrarian investing is a form of active investing, since contrarians seek to outperform the market rather than keep pace with market gains. Contrarian investing also aligns more closely with long-term investing than day trading, as contrarians often have a timeline that spans weeks, months, or years.
Contrarian investing may overlap the most with value investing. Both approaches look for opportunities that have been overlooked and misjudged by the majority of investors. Both look for stocks that are undervalued or have a stock price below their estimate of a company’s intrinsic value.
Finally, contrarian investors may find themselves aligned with short sellers who bet on falling prices by “shorting” a stock or profiting from a stock when its price falls. Even so, contrarian investors generally have a longer timeframe than short sellers and are just as focused on investment opportunities that require asset prices to rise.
Advantages of contrarian investing
Contrarian investing is attractive for two main reasons. When it works, contrarian investors can identify opportunities where the herd mentality in the market is wrong and potentially outperform other investors in the process.
By going against the grain, contrarian investors may be able to reap big gains, as long as they have the time and patience to wait for their prediction. For example, a popular contrarian strategy is to invest in stocks in the middle of a bear market or when stock prices are falling.
Even if contrarians do not correctly identify the exact bottom of the market, by buying when other investors are rushing to sell, contrarians can see their investment pay off once stock prices start to rise again.
Finally, opposites can find great personal satisfaction in investing themselves as such. Because this style of investing requires a great deal of research and market expertise, investors may find it rewarding — beyond financial gains — when their outlook turns out to be correct.
Disadvantages of contrarian investing
Developing a contrarian view requires a great deal of curiosity and independent thought, as well as the time to research how individual stocks, broader stock sectors, or even the market as a whole are trading.
There is a level of courage that is required of contrarian investors to maintain an off-consensus view, particularly if investors have to wait a while to see if their theory is correct. Contrarian investors need to have both the time and the money to wait, particularly because they could experience short-term underperformance in pursuing their contrarian strategy.
There is an opportunity cost to tying up money in a contrarian strategy that can take months to materialize, and investors need to be comfortable with this kind of risk.
Contrarian investing is also not as accessible to most investors as other investment strategies, given the time and research required to develop solid contrarian theories. The prospect of proving other investors wrong is tantalizing, but it is difficult to properly time the buying and selling required by the contrarian strategy.
Famous contrarian investors
Warren Buffett is known as a value investor, but much of his approach to investing is also contrarian. Buffett built his wealth by successfully finding pockets of opportunity in the stock market, and his stock picks are closely scrutinized for their validity and ultimate value as investments.
Even so, Buffett warned investors not to fall for the trappings of any particular investment strategy: “Don’t get caught up in what other people are doing,” he said. “Being against the grain isn’t the key, but neither is being a crowd follower.”
One of the main characters in Michael Lewis’s book The Big Short has become a face for contrarian investing. Michael Burry, a hedge fund manager, was among a small group of investors who correctly predicted a bubble in the subprime housing market. As with Burry, other professional money managers and hedge fund managers have become famous for their contrarian bets, including Bill Ackman, George Soros, Ray Dalio and Marc Faber.
Recent history also highlights a contrarian view that has become the prevailing one. In early 2021, a group of stocks that had fallen out of favor with professional investors caught the attention of amateur traders on social media. So-called meme stocks, including GameStop and AMC Entertainment, quickly saw huge gains.
While some traders took advantage of what started out as a sort of contrarian theory, the fundamentals (revenue and earnings) of these companies ultimately couldn’t sustain the higher prices these stocks have seen, and they then fell again.
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