Contrarian investing is all about doing the opposite of what the majority is doing. So if you’re selling, contrarians are buying and vice-versa.
Contrarian investing is an investment method where you go for assets that are currently out of favor. So if the stock market is having a selloff, contrarian investors take that opportunity to make a purchase, or they sell when there is a lot of buying taking place.
Contrarian Investing Explained
In the wise words of Berkshire Hathaway CEO Warren Buffett. “Be fearful when others are greedy, and greedy when others are fearful.”
Contrarian investing is a strategy that involves deliberately going against the prevailing flow and finding opportunities in poor market situations. In other words, you’re buying when the majority are selling and selling when the majority is buying.
Contrarian investors usually put money into assets that currently don’t appear promising in hopes that they will improve over time. Such an approach requires a great deal of research and time analyzing the market.
Let’s say the market outlook at the moment is that the economy will grow faster than expected, strengthening the market further. A contrarian could then choose to invest based on the possibility that the economy will not expand at a quicker pace than predicted and that stocks will weaken.
As mentioned above, contrarian investing requires a significant amount of time. It could take investors weeks or even months to work out an entirely contrarian outlook of the markets. And longer for them to reap the rewards.
Being a contrarian investor can be worthwhile as long as you’re ready to take the risks and potential losses associated with waiting for long periods.
Basically, the plan here is to make investments contrary to the prevailing sentiment and as early as possible so you can put your money to work before the overall market outlook shifts in your favor.
Understanding Contrarian Investing
Contrarian investing starts with fully grasping the general market perspective. That can involve a single stock, a particular sector, or the overall market. The next step is to find holes in that perspective that would help you build a case that supports your contrarian assessment.
So if the majority have a bullish view of the stock market due to expectations of faster economic growth, a contrarian investor can develop a bearish view of the overall market or its sectors.
Contrarian investors can also take a bullish stance when most market players are bearish. That often happens to individual stocks or sectors that lose investors’ interest. Hedge funds, for instance, are usually looking for aggressive contrarian investment methods.
For contrarian investors, it’s not about the money they can make in the short term. Rather, it’s about finding opportunities in the market where they believe the popular belief may not be correct in hopes that they can turn a profit as other investors reassess their view.
Therefore, being a contrarian investor means that you should be willing to accept short-term losses and the uncertainty associated with waiting for your contrarian prediction to be confirmed.
Contrarian Investing is Active Investing
Contrarian investing involves actively buying assets that others are selling and vice-versa. It is an active style of investing that aims to beat the market rather than keep up with its increases.
Furthermore, contrarian investing is more similar to long-term investing than day trading since the investment horizon of contrarians can span from weeks to months to years.
Value investing is perhaps the closest to contrarian investing. These two strategies look for opportunities that most investors have missed or excluded and mispriced.
Plus, value and contrarian investors prefer underpriced stocks, markets, or sectors where the share price is lower than their estimate of a firm’s intrinsic value.
Contrarian investors are also like short-sellers who put money into declining stocks by shorting them or generating returns on a stock when its share price drops.
Still, contrarian investors differ from short-sellers due to their timeline, although they are pretty much the same when it comes to seeking out opportunities that require prices to go up.
Benefits of Contrarian Investing
Contrarian investing has two key benefits, as long as it works properly. The first one is that it helps you find opportunities where most investors are wrong. That leads you to the second benefit, which is a head-start over other investors.
You could earn big by going against the flow, provided that you have the patience and time to wait until your outlook is proven right. Betting on stocks amid a bear market or declining prices is one popular approach among contrarian investors.
Moreover, even if contrarians were not spot-on with their estimate of the market bottom, buying when the others are selling can help them reap gains once stocks start trending upwards again.
Being a contrarian investor can also offer a benefit beyond financial rewards. Contrarian investing requires a great deal of research and market knowledge. So if your prediction turns out to be accurate, you may be able to gain a sense of fulfillment in being a contrarian.
Factors to Consider in Contrarian Investing
Contrarian investing can be challenging due to the steps involved and the list of tasks you need to do.
You have to be eager to learn and understand and be confident enough to rely on your own decisions to guide you on the right path. You also need to be willing to spend a lot of time researching how individual stocks, stock sectors, or the overall market trades.
Time and money must be considered in contrarian investing as well. Contrarian investors must have time and money since they may have to deal with some short-term weaknesses while waiting for their investments to hopefully generate returns.
You also need to note that contrarian investing comes with the risk of using your investment dollars to bet on out-of-favor securities that may take months to pay off.
In addition, contrarian investing is not as simple as other investment methods, considering the research and time you have to put into building a rational contrarian view.
The idea of proving other investors wrong may be exciting, but it is not easy to precisely time the purchase and sale that are essential for a contrarian approach.