Contrarian Investing – What It Is, and Does it Work
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While I’m on vacation I have guest posts lined up to fill in for me. The following is a guest post from Tony at Investorz Blog, which is an investment blog aiming to help other individual investors.
Contrarian investing is going against the crowd and attempting to profit when the crowd’s investment choices seem to be wrong.
A contrarian investor prefers to go against the crowd, because the crowd’s irrationality often misprices stocks, commodities, etc. For example, a contrarian investor will sell if the the general consensus if to buy, hence going against the crowd’s thinking. A contrarian investor will buy if the crowd is feeling pessimistic.
People often confuse contrarian investing with being permanently bearish. I would like to correct that confusion, because a true contrarian investor neither stays permanently bullish nor permanently bearish on securities. The goal of a contrarian investor is to find irrationality in the markets, and profit from that mispricing.
Contrarian investing is often compared to value investing in that a contrarian investor sells when the markets are overvalued, and buy when the markets are undervalued. However, a pure value investor would only look at things such as P/E ratios and book value, but a contrarian investor would also include in his or her analysis less countable things such as market sentiment.
Does contrarian investing work?
It absolutely wrangles me when someone mentions Warren Buffett’s line “be greedy when others are fearful, and fearful when others are greedy”. I believe Mr. Buffett is wrong. Let’s take a look at an example. Remember Lehman Brothers? The financial services company that went bankrupt in 2008? If you had bought their stock in August 2008 (because others were fearful), you would have been killed.
I would rephrase Buffett’s line into “be greedy when there’s no bullishness left at all in the market, and be fearful when utter europhia has taken control of the markets”. Of course, this doesn’t apply to investing in individual stocks, because individual stocks can go bankrupt, while the overall market (Dow Jones ETF, etc) can’t. Below is a typical investment of a self proclaimed contrarian investor.
It is very difficult to avoid the screams of pain and bearish noise in a stock market crash. Hence, it’s better to buy late in the cycle of market fear than to buy early.
So what are your thoughts on contrarian investing?
Ashley
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Comments
Contrarian could also be interpreted as seeking and redefining value where others (e.g. the crowd) is unable to see value. An example could be a beat-up looking piece of furniture at a yard sale, picked up for spare change and restored to a beautiful finish – and increased value – with a minimum of effort.
Assets need not only be thought of as stocks, bonds, and real estate.
I think the general sentiment behind Buffett’s statement still stands. When the crowd is overly optimistic, then it is time to start selling. When the crowd is overly pessimistic, then it is time to start hunting for bargains. Of course, Buffett likes to purchase with a margin of safety as well. You can’t forget that.