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4 things to know about Contrarian Investing
In 2009, the world was hit by a dreadful financial crisis. Naturally, investors panicked and stock markets across the globe crashed. What is the conclusion of this phenomenon? Investors sell when others sell. Similarly, you may often see the markets go on rising for a period of time when investors are happy. Someday, though, this bubble will burst. However, investors bought when others did. This is the epitome of herd mentality. A large chunk of investors blindly follow the investment pattern of experienced investors. They are often the worst losers.
This is why there are many investors who avoid following the herd and choose to go against the market trend. This is called contrarian investing. The biggest proponent is the ace investor, Warren Buffett. "Be greedy when others are fearful, and fearful when others are greedy," is his mantra.
Here are four things to know about contrarian investing:
Who is a contrarian investor?
A contrarian investor is unconventional. He tries to make profit in the stock market by going against the prevalent popular trends. This does not mean that he will avoid a good stock which is profitable if it is being bought in droves. He or she will avoid it only if the stock is priced too high. The best example is of an investor who swoops in to buy shares of a company, which just saw its stock slump. It is all about buying stocks cheap and selling it at highs.
The rationale behind contrarian investing
When you hear a particular company's share is doing really well you then want to buy it. Similarly, any negative news may discourage investors to sell the stocks in a panic. A contrarian investor believes that many investors unnecessarily panic and overreact to the news. This often leads to a stock jumping more than required or under-valuation of share prices. In such an event, the share price does not reflect its true inherent value. In the long run, stocks almost always fall or rise to their true value. He realises the mismatch between the prevalent share price and the true value of the share. This encourages him to buy the shares of a company which is otherwise out of favor. The contrarian investor, thus, looks at the long term prospects.
Benefits of contrarian investing:
Timing is very important in such investments. If the transaction is carried out at the right time, contrarian investing helps an investor gain high returns. Take this for an example: you bought 500 shares of a company at Rs 50 apiece, when everyone else exited the company. After the company posted profits, its share price zoomed to Rs 300. On selling, you make a profit of Rs 250 apiece-that's a whopping Rs 1.25 lakh*.
Where there is profit, there is always risk. You have to ride the volatility while investing against the market. Patience, thus, is very important. Without proper research and timing, contrarian investing can be very risky, with a potential for high losses. Moreover, it is easier said than done to go against the prevalent sentiment in the market. There may be times when the company really does not have a good potential.
In 2009, the Sensex slumped to 8,300 levels just a year after it touched the then-lifetime high of 20,000. This is because investors panicked when the US stock markets crashed. The US financial crisis triggered the fall. In 2015, just six years later, the Sensex soared to near 30,000-levels. If an investor had invested against the herd in 2009, his Sensex portfolio would have jumped 160%. That's big moolah!
*The above example is an illustration only. It should not be construed as an investment advice.