Learn To Think Like A Contrarian

If there’s one thing that the market of the last few years has taught us it’s that there’s very little that’s predictable.  You think things are at their worst and suddenly the market shoots up.  You think the bull market has returned and then you hear that the economy might be slipping back into recession.  You’re not sure what to do so you might think that just following the consensus of the investing public is a good strategy.  More often than not that thinking is wrong.

Contrarian view

If you’ve ever paid attention to the people who try to study the behavior of investors, you’ll hear them use terms like “herding” and “groupthink”.  People who display these behaviors tend to abandon their own logical thought process and choose instead to follow the behavior of the investing public at the time.  You need only to look back to the tech bubble of a decade ago when people were piling into internet stocks just as they were about to crash as a prime example of why this kind of thinking can be very dangerous.

It also has a lot to do with investors chasing returns.  A certain group of stocks, like internet stocks, performs really well and investors want to jump on a catch a piece of it for themselves.  There may not be much logic in why they want to buy.  They just know that they want to get in before it’s too late.

So how do you avoid falling into this trap?  How about doing the OPPOSITE of what the public is doing?

This type of thinking is called a contrarian investing strategy.  It can be a bit counterintuitive as this strategy looks to make money by going against the consensus.  It sounds somewhat ridiculous.  Why would one choose to sell when things are going up?

It’s actually a much more logical strategy than it may sound like.  The basic tenet of investing is to buy low and sell high.  Using the tech bubble as an example, many investors were buying high in hopes that stocks would go higher yet.  Once stocks tumbled, they got out not wanting to stomach any more losses.  What were they essentially doing?  Buying high and selling low.

Contrarians aim to do the opposite.  If they go against the grain by selling when things look their best and buying when things look their worst, they’re attempting to buy low and sell high.  There’s proof that this strategy works too.  Perhaps the world’s most famous contrarian is none other than Warren Buffett.  He’s cemented a long legacy of buying beaten down companies and sectors and waiting until the market realizes their full value.

You may not have the resources of a guy like Warren Buffett but there are options for regular investors who choose to try this strategy.  The Fidelity Contrafund, one of the largest mutual funds in existence, looks to maintain a contrarian strategy in managing its portfolio.  Janus also offers its Contrarian Fund as an alternative.

Investing contrary to what the general public is doing can take a bit of courage but remember that the majority isn’t always right.

Photo credit: Fikry Botros

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Author Info

This post was written by David Dierking. David lives outside Milwaukee, Wisconsin and has been working in the financial services industry for over 13 years with a background in investments, accounting, and marketing. He earned his Chartered Financial Analyst designation from the CFA Institute in 2004 and was recently published in the Milwaukee Business Journal. You can also check him out at The Ultimate Fit Challenge

2 Responses to “Learn To Think Like A Contrarian”

  1. John Diggers |  Oct 11, 2010 at 9:14 am

    As my dad used to always say, always expect the unexpected. Thanks for the interesting post.