Contrarian investing is a common approach in the financial market that can generate huge profits within a certain period. Famous investor Warren Buffett, Chair and Chief Executive Officer (CEO) of Berkshire Hathaway, uses this method of investing, which has already provided him with a huge return.
The financial market always shows a herd mentality when buying or selling occurs on any particular trading instrument. However, it is mandatory to have a proper understanding when using this method to make trade decisions.
This article will introduce you to contrarian investing, how it works, how to use it, famous contrarian investors, etc.
What Is Contrarian Investing?
As we said, the financial market involves herd mentality in most cases. When the market is booming, investors believe it will keep gaining or expect the price to drop by the weekend when it is in a downtrend. So they place by or sell according to the trend depending on their trading technique.
On the other hand, contrarian investors keep buying while the asset price is falling and sell the stocks upon recovery. Meanwhile, they keep selling the stock when the price rises as they seek to make a profit when the price drops. It means contrarian investors keep entering the market when it is out of favor.
Successful contrarian investors keep track of the market and conduct efficient research to predict future price movements. So it is common for these investors to spend time in their market research to find the best opportunities by evaluating market data. Warren Buffett states, “Be fearful when others are greedy, and greedy when others are fearful.”
For example, the prevailing market sentiment may support that the price will accelerate of any particular trading instrument as it remains on an uptrend. Meanwhile, a contrarian investor may find selling opportunities as his research supports that the current trend will end. Developing a contrarian viewpoint can take weeks, months, or even more time, and Contrarian investors take action before the market shifts.
How Does The Contrarian Investing Work?
When the stock market is gaining, investors’ temptation is to enter the market and ride the trend as long as the stock remains on an uptrend. However, investors keep out of that asset if the price declines to limit potential losses. This approach is reasonable, as why will you purchase an asset that is falling?
Contrarian investors usually go against the consensus view. The strategy is to short the stock while gaining or buying when the price drops. It can occur for any stock, a broader stock market sector, or the whole market. So, in a “bear case” scenario, they may seek “bull case” opportunities and vice versa.
For example, many tech stocks have been gaining for several years while energy stock is declining. Contrarian investors may find energy stocks attractive to invest in. These investors do not usually invest for short-term gain; they identify overpriced or underpriced investment assets and get paid off when the consensus view is wrong.
Contrarian Investing Vs. Other Investing Strategies
Contrarian investing is a method of active investing that does not keep pace with market gain. You can group this investing as a long-term investment strategy rather than day trading or short-term investing, as most contrarian traders often have timelines of trading a week, month, or year. You may detect contrarian investing mostly overlap with value investing.
Being a contrarian investor means being cautious for mathematical, rational reasons. When most investors may be afraid and avoid a particular stock, you become optimistic and seek trade opportunities on that underpriced stock or the share price is below the company’s intrinsic value.
Legendary traders or most successful stock traders who may manage millions or billions of dollars in funds were value investors, which by extension means contrarian investors as they saw the value of any specific asset when others might fail to detect it. They may avoid particular assets when other investors may be enamored with by investing their money.
Legendary investor Warren Buffett said, “I will tell you how to become rich. Close the doors. Be greedy when others are fearful, and fearful when others are greedy.”
Why Is Contrarian Investing Attractive?
When there is extreme market volatility, investors seek to put their money in “safe-heaven” assets like bonds or cash. The reason is to protect their portfolio from potential losses. They can miss valuable investment opportunities. There are optimal points to buy some asset when everyone else isn’t doing it.
For example, during the tech bubble at the beginning of this century, investors started investing in overpriced tech stocks by supporting the bubble. Then the tech bubble turned into a bust, so no wonder many investors who were following the bubble ended up in the nursing home by losing money. In contrast, many trading assets reformed during that period in a downtrend. No wonder contrarian investors were selective in tech stocks.
According to their analysis, some of them identified stocks that reformed or started gaining in that period after being downtrend and placed positions that gave them huge gains.
Most recently, the financial crisis in 2009 opened opportunities for contrarian investors. Those brave at that time and invested in potential stocks enjoyed huge profits during recovery. Observing past performance and relevant factors that drive price movements is essential, although past performance doesn’t guarantee any future profit. Contrarian investors wait a significant time to determine investment opportunities or an upturn that may not appears at all.
How To Detect Contrarian Investing Opportunities?
There are many funds available that contrarian investors manage, which is the best way to understand their investing strategy. Fearless investors can choose stocks or investment assets independently; they must consider several vital factors. The first thing is to avoid outperforming stocks with rumors. Any trading asset may reach a peak doesn’t mean the fortune will continue the same in the future. There are always ups and downs in stock prices as there are tough times to consider for companies that issue the shares.
Another vital factor to consider is the earning ratio or P/E ratio. The concept is higher P/E ratio declares the investment asset is potential; it doesn’t mean a low P/E ratio means a bad investment asset or stock; it means the broader market makes the asset overvalued. You can compare the P/E ratio of stocks in the same group to get a clear idea of how your target stock is measuring up with others in the same group.
Contrarian investing is always a method for investors with specific skills. Moreover, contrarian investors research the market using several calculation factors or indicators that signals the future performance or current condition of a particular investment asset. Contrarian investors use long-term investment strategies to generate considerable revenue/profit and take more significant risks than any short-term traders.
Advantages Of Contrarian Investing
Contrarian investing has two significant advantages-
- First, they conduct sufficient research when choosing any stock. So their level of satisfaction is always better than average investors. Investors find this research and even can use it to get short-term gain.
- Secondly, contrarian investors invest in the opposite direction of the current trend by identifying herd mentality. They put buy when the price declines, when the price recovers, then they sell. So usually, get the asset at a low cost, sell it at a high price, and generate more profit than investors with common strategies.
Disadvantages Of Contrarian Investing
Developing a contrarian viewpoint requires time, research, patience, independent thinking, and curiosity. Contrarian investing involves money and time, besides all other aspects of investing. Moreover, contrarian investors must be capable of taking considerable risks as they always bet against the current trend. This investment strategy pays off huge within a particular time that can be weeks or months long. So a contrarian investor must have patience and bear the enormous investment risk.
Famous Contrarian Investors
A well-known investor Warren Buffett is familiar with his value investing strategy, but his investment style is similar to contrarian investing. This legendary investor made his wealth from the investment opportunities within the stock market. He says, “Don’t get caught up with what other people are doing,” and “Being a contrarian isn’t the key, but being a crowd follower isn’t either.”
Michael Lewis’s book “The Big Short” introduces the main character who faces contrarian investing. A hedge fund manager, Michael Burry, was among the small group of investors who had the correct prediction about the subprime housing market bubble.
As Burry, many other hedge fund managers and money managers have become famous for their contrarian bets, including Bill Ackman, George Soros, Ray Dalio, and Marc Faber.
Final Thought
Finally, so now you know what contrarian investing is. So as you see, it requires particular skills to become a successful contrarian investor. We suggest doing some additional research before placing any contrarian investing. Don’t hesitate to spend sufficient time to detect contrarian investment opportunities, as the reward is considerable when you catch a perfect investment opportunity.
FAQS: What Is Contrarian Investing?
How to define a contrarian investor in one sentence?
Answer: They are buying cheap and selling expensive.
Why Is Contrarian Investing Difficult?
Answer: Contrarian investing is difficult as it takes much time, research, patience, and skills to develop a contrarian investment plan.
Contrarian investing is a strategy used in the financial market that involves going against the prevailing market sentiment. It is based on the belief that the market often exhibits herd mentality, with investors buying when prices are rising and selling when prices are falling. Contrarian investors, on the other hand, buy when prices are falling and sell when prices are rising. This approach aims to identify overpriced or underpriced investment assets and take advantage of market inefficiencies.
Contrarian investors typically conduct extensive research and analysis to predict future price movements. They may spend a significant amount of time evaluating market data and identifying opportunities that others may overlook. One famous contrarian investor is Warren Buffett, the Chair and CEO of Berkshire Hathaway, who has achieved significant returns using this investment approach.
Contrarian investing works by going against the consensus view. Instead of following the crowd, contrarian investors take positions that are contrary to popular opinion. They may short stocks that are overvalued or buy stocks that are undervalued. This strategy can be applied to individual stocks, sectors, or the entire market. Contrarian investors often have a long-term investment horizon and focus on identifying investment opportunities that others may miss.
Contrarian investing differs from other investment strategies such as day trading or short-term investing. It is considered a long-term investment strategy that requires patience and a contrarian viewpoint. Contrarian investors often have timelines of trading that span weeks, months, or even years. This strategy overlaps with value investing, as contrarian investors seek to identify assets that are priced below their intrinsic value.
Contrarian investing can be attractive for several reasons. During periods of extreme market volatility, when investors flock to "safe-haven" assets, contrarian investors may find valuable investment opportunities that others are missing. By going against the crowd, contrarian investors can take advantage of market inefficiencies and potentially generate significant profits. However, contrarian investing also has its challenges. It requires extensive research, patience, independent thinking, and the ability to take significant risks.
To detect contrarian investing opportunities, investors can consider several factors. They should avoid investing in stocks based on rumors and instead focus on fundamental analysis. Evaluating the price-to-earnings (P/E) ratio can provide insights into whether an investment asset is overvalued or undervalued. Comparing the P/E ratio of stocks within the same group can help investors assess the relative value of a particular stock.
Contrarian investing has both advantages and disadvantages. On the positive side, contrarian investors conduct thorough research and analysis, which can lead to a higher level of satisfaction compared to average investors. They also have the potential to generate higher profits by buying low and selling high. However, contrarian investing requires time, research, patience, and the ability to take significant risks. It is not a strategy that guarantees immediate returns and requires a long-term perspective.
Some famous contrarian investors include Warren Buffett, who is known for his value investing strategy, and Michael Burry, who correctly predicted the subprime housing market bubble. Other notable contrarian investors include Bill Ackman, George Soros, Ray Dalio, and Marc Faber.
In conclusion, contrarian investing is a strategy that involves going against the prevailing market sentiment. It requires extensive research, patience, and the ability to take significant risks. Contrarian investors aim to identify overpriced or underpriced investment assets and take advantage of market inefficiencies. While it can be challenging, contrarian investing has the potential to generate significant profits for those who are able to identify and capitalize on investment opportunities.
