What is Contrarian Investing?

Numerous investors are termed based on their investing style. Some use algorithm trading, some follow value investing, some are simple traders etc. Among these is a type of investor who believes in not following the herd and the general market sentiment. They are called Contrarian investors and follow an investing style called Contrarian Investing. In our quest of infusing financial literacy, this blog will detail Contrarian Investing to answer ‘What type of investor are you?’ better.

Contrarian Investing

Contrarian investing is a type of investing style that believes in going against the general market trend and investor sentiment. Following the contrarian investing strategy, investors purposely take positions that are opposite to the herd. A contrarian investor buys stocks. when others are selling and sells stocks when others are buying.

The main assumption behind contrarian investing is that the markets are often subjected to behaviour that is triggered by investor greed and fear. They believe that if they go with the herd mentality, they can suffer losses, which is why they go against the market in their trades.

How does Contrarian Investing work?

In contrarian investing, investors believe that when other investors promote the potential rise in the market, they do so because they are fully invested and have no further purchasing power. In this case, the market is at its highest bull peak, which can only go down further. While other investors may start investing more at this point, contrarian investors start selling to book profits and mitigate future losses because of a potential trend reversal.

On the other hand, if other investors are promoting a fall in the market, it means they have already sold almost all of their investments, making contrarian investors believe that the market will only go upward. In this case, they start to buy stocks and make profits if the market goes up, based on the price fluctuations.

The basic principle followed by contrarian investing is attributed to beginner and next-generation investors. These next-gen investors usually overreact to events, news and other developments regarding a specific company, which results in overvaluing an ‘in-demand’ or ‘hot’ stock and undervaluing the decent earnings of a distressed stock.

This overreaction triggers herd sentiment and raises the volume by a huge margin, resulting in limited upward movement for distressed stocks and a massive fall in the prices of ‘hot’ stocks. Contrarian investors, then, enter the market as they have a great opportunity to buy underpriced stocks. With the steep fall, the market now can only go up, and since contrarian investors have bought the stocks at a low price, they make profits with the price rise.

How to spot a potential Contrarian opportunity?

The best way contrarian investors spot a potential contrarian opportunity is through analysing the general market trend and investor sentiments. For example, if you think you are reading continuous news about the market or a stock that is going to rise, it can be a starting point for you to execute contrarian investing. In the long run, it is almost certain that every stock goes to its true value, whether up or down.

If some stocks are in the news, it makes them hot stocks. You can then start monitoring them and perform detailed technical and fundamental analyses to understand their true value. As there is a possibility that the investors may overreact, you will see a sudden jump in the prices of these stocks. Once they are at their peak, you can wait for them to fall and then enter by buying these stocks at a low price. As they will go to their true value, you will make profits.

Final Word

"Be fearful when others are greedy, and greedy when others are fearful". This is a quote by Warren Buffett, one of the best investors of all time and effectively defines the concept of contrarian investing. However, in its essence, contrarian investing can be risky if it is not complemented by detailed research through technical and fundamental analysis. Only then you can learn about the true value of a stock and successfully execute contrarian investment strategies.