Contrarian Investing refers to a well-known style of investing which invests against the main going and popular market trends of the day. It does so through purchasing those assets which are performing poorly to later resell them when they outperform. An individual who proves to be a contrarian investor is of the opinion that those analysts who argue the market will rise are only doing this because they have fully invested their own funds and therefore have no additional purchasing power remaining to them. This would then be the market’s peak. Similarly at that point when the analysts and so-called gurus argue a downturn is overdue they have already sold out their own holdings.
Another factor of contrarian investing has to do with those securities which have fallen from favor and therefore possess lower price to earnings ratios. This strategy involves selling and buying in the opposite direction of what the mainstream investors are doing at that given moment in time. They would then choose to wade into the market as other investors feel negative on it and that the value is cheaper than its true intrinsic value.
Overwhelming pessimistic sentiment on any given stock means that the price could be unfairly punished. Contrarians feel that the risks and downsides on the issue have already been blown out of proportion. The trick lies in determining which distressed stocks they should purchase or sell as the company makes a recovery and the stock price recovers accordingly as well. It often times means that the associated stocks will regain value at a far quicker pace than is normal for mid to large cap stocks. At the same time, having an over optimistic opinion on stocks which are over hyped can cause the opposite impact.
The character trait that many different contrarians share is their eternal view of an oncoming bear market. This is called the perm bear syndrome. They may not feel the market will be negative, yet they remain cautiously skeptical on the way that the mainstream investors view the stock markets. They realize that valuations which rise too high will finally end in inevitable declines as the growing expectations of investors do not pan out in the end. Such contrarian principles may be utilized effectively not only with entire markets, but a given industry or even individual company stocks.
This also means that contrarian investing shows many of the hallmarks of classical value investing. The two types of investors are seeking out price discrepancies which would mean that a given asset class is not fairly or fully valued in the given market conditions. There are countless value investors who believe that only a fine line exists between contrarian and value investing since they are both seeking out profits on undervalued securities.
One critical difference between the two disciplines lies in the relative importance of the Price to Earnings ratio, which is centerpiece of value investing. Contrarian investors will naturally consider it but more importantly attempt to ascertain the qualitative mood on the overall market. This means that they place priority emphasis on trading volume, analyst forecasts, and the tone and substance of media commentary.
The contrarian investors also put a lot of value on the basic principles of behavioral finance. They believe that investors act as a large collective and interact with trends as such. When stocks perform badly, this means that they will remain in this trend for a while. Similarly, stronger performing stocks will stay buoyant for many market sessions until something comes along to upset this powerful market moving trend.