What is Contrarian Investing?

Key Highlights

• Contrarian investing is an approach that attacks current market trends and sentiment.

• According to the theory, markets are subject to a behavior called herding that is fueled by fear and greed, which causes them to overprice and underprice occasionally.

• It can be rewarding to be a contrarian, but it's a risky strategy that can take a long time to pay off.

Understanding Contrarian Investing Meaning

Contrarian investing is a type of investment style that believes in going against the general market trend and investor sentiment. Investors tend to intentionally take positions that are in contrast with the herd, following a contrarian investment strategy. A contrarian investor invests in stocks. When others sell and buy stocks, others buy.

In the case of contrarian investing, it is commonly assumed that markets are often subject to behavior caused by investor greed and fear. They think they're going to lose money if they go with the herd mentality, so they're going against the market in their business.

How Does Contrarian Investing Work?

In contrarian investing, investors believe that when other investors support the potential rise of the market, they do so because they are fully invested and have no other purchasing power. The market is already at its highest bull point in this case, and it can fall even further. At this juncture, other investors may be beginning to invest more as long as a trend reversal is possible. Still, contrarians are starting to sell in order to book profits and mitigate future losses.

Conversely, when other investors are promoting a downturn in the market, it means that they've already sold off nearly all their investments, which makes contrarians think there will only be an upswing. If the market goes up on the basis of price fluctuations, then they start buying stocks and making profits. The fundamental idea of contrarian investing belongs to beginners and younger investors. Usually, these younger investors overreact to news, events, and other developments pertaining to a particular company, which causes them to overvalue "hot" or "in-demand" stocks and undervalue the respectable earnings of troubled stocks.

This overreaction provokes herd concerns and increases the volume by a substantial margin, leading to restricted fluctuations in distressed stock levels as well as sharply lower prices for 'hot' stocks. Contrarians, on the other hand, are entering the market because they have a great opportunity to buy cheap stocks. The market is only going to rise with the steep fall, and since contrarian investors bought stocks at a low price, they're going to profit from the rise in prices.

Contrarian Investing Examples

Contrarian investing is an investment strategy that seeks to make a profit from investments that go against current market sentiment. For example, a contrarian investor will be bearish when the market is bullish, looking for opportunities to sell. On the contrary, when the market is down, contrarians are highly optimistic and look for opportunities to buy.

How to Use a Contrarian Investing Strategy?

The following points should be taken into account for the start of contrarian investing.

1. Extreme sentiment

Contrarian investors will actively seek to identify such instances when market sentiment is excessively positive or negative. They spot extreme optimism or pessimism indicators, such as sharp price falls (despair) or sharp price gains (euphoria).

2. Overvaluation and undervaluing of assets

During periods of high optimism and when extreme pessimism is prevailing, contrarians seek out overvalued assets. These are stocks with low price-to-revenue ratios, strong firms with a temporary drop in the price of shares, or sectors that have the potential for longer-term growth.

3. Research and analysis

Contrarian investors carry out research and fundamental analyses. It analyses factors such as financial health, potential earnings, industry trends, and economic conditions with a view to determining whether an asset is truly worth it. They are trying to understand if there is any justification for today's opinion and whether hidden factors have gone unnoticed.

4. Patience and perspective

The Contrarians realize that market acceptance of their views may take some time. Therefore, they are holding their investments through adversity and expecting market sentiment to change and asset prices to be adjusted in line with actual value.

5. Contrarian positions

Once identified, contrarian investors take positions that are contrary to current market sentiment. For example, when sentiment turns negative, contrarians can buy undervalued assets to buy undervalued stocks at discounted prices in an overly bearish market.

Pros and Cons of Contrarian Investing

Pros The advantages of contrarian investing are as follows.

Buying stocks when they are not in favor creates an important margin of security relative to intrinsic values, thus reducing downside risk. As a contrarian investor, your portfolio is more likely to do better over the long term than the market.

Cons The drawbacks of contrarian investing are as follows.

In the face of overwhelming negative sentiment about investments, it can be mentally difficult to maintain your investment commitment. Contrarian investments require creative thinking, market expertise, time to conduct research, and a preference for longer-term outlooks. The process, which requires years of experience and investment styles that may easily be lost in the influence of short-term noise, is hard practice. Before your contrarian investment strategy starts to pay off, your portfolio is likely to disappoint for a long time. If market sentiment shifts for legitimate reasons in a way that continues to delay your timely payoff, you can also miss expected gains.

Conclusion

To sum up, it's not for everyone to invest in contrarian investing. However, this strategy may be very rewarding for people who are ready to undertake research and keep their discipline. In essence, however, if comprehensive research is not added through technical and fundamental analysis, it can be risky for contrarian investing. Then, you will be able to learn about the underlying value of a company and successfully implement countervailing strategies for investing.