When the majority is saying something, a contrarian will declare it is wrong. Choosing to invest in assets that run counter to market sentiment is known as contrarian investment. Contrarian investors purchase when the stock market is falling, or they sell when there is a flurry of purchasing.
What Is Contrarian Investing?
Financial markets almost always favor the herd mentality. The majority of market players concur that either the stock market is performing well and should continue to post gains or that the market is struggling and will be lower next week than it is right now.
Holding an unpopular opinion about the market and conducting the appropriate research to ascertain whether there is an investment opportunity is known as contrarian investing. Successful contrarian investors must be prepared to put in a lot of time analyzing market circumstances in order to support their position.
A contrarian investor can choose to make investments based on the premise that the economy won't develop faster than it is now and that stock prices will fall, for example, if the general market opinion is that the speed of economic expansion will quicken, generating more market gains.
The famous contrarian investor Warren Buffett aptly encapsulated the idea when he said, "Be greedy when others are scared, and fearful when others are greedy."
An investor may need several weeks or months to completely build a contrarian opinion, and it may take even longer for their plan to succeed. Investors who take a contrarian approach must feel at ease with the risks and possible losses involved in holding back. Contrarians seek to enter trades before the prevailing view changes in their favor by making early investment selections that are consistent with their point of view.
How Does Contrarian Investing Work?
Understanding the prevailing opinion in great detail is the first step towards contrarian investing. This may apply to a specific stock, a larger stock market sector, or the market itself. A contrarian investor then finds flaws in the consensus and constructs a case to support their contrarian viewpoint.
A contrarian investor might develop a "bear case" for the market as a whole or for specific sectors within it, for instance, if the majority view is a "bull case" for the stock market based on growing economic growth.
A contrarian investor could also be bullish while gloomy opinion is in vogue. This is especially true for specific equities or stock markets that have lost popularity. For instance, hedge funds, which pool investor money, frequently look for aggressive contrarian investment methods.
Investors that take a contrarian approach do not want quick profits. The idea is to locate areas of opportunity inside the market where they think the conventional wisdom is incorrect in the hopes that their investment will succeed when other investors change their perceptions.
Investors who take a contrarian stance must therefore be prepared to accept short-term losses as well as the uncertainty that comes with holding out for confirmation of their hypothesis.
Contrarian Investing vs Other Investing Strategies
Since contrarians want to outperform the market rather than keep up with its gains, contrarian investment is a type of active investing. Because contrarians frequently have a timescale that is weeks, months, or years long, contrarian investment also resembles long-term investing more than day trading.
Value investing and contrarian investment could have the most in common. Both strategies look for opportunities that the bulk of investors have missed or priced incorrectly. Both are looking for stocks that are undervalued, or where the share price is less than what they believe a firm is truly worth.
Finally, it's possible for contrarian investors to join themselves with short sellers, who wager on dropping prices by "shorting" stocks, or making money from a stock when its share price falls. Even said, contrarian investors are equally focused on investing opportunities that require asset prices to rise and often have a longer time horizon than short sellers.
Advantages of Contrarian Investing
The appeal of contrarian investing stems from two main factors. When it succeeds, the contrarian investor can spot opportunities where the market's herd mentality is incorrect and possibly outperform other investors.
As long as they have the time and patience to wait out their prognosis, investors who choose to go against the grain may be able to make significant profits. To invest in stocks, for instance, during a bear market or when stock values are declining, is a common contrarian strategy.
Contrarians can profit from their investment after stock prices start to rise again, even if they don't precisely predict the market's bottom. This is because they buy when other investors are rushing to sell.
And finally, being invested as a contrarian can bring a lot of personal gratification. Investors may find this form of investing rewarding—beyond the monetary gains—when their outlook turns out to be accurate because it necessitates a lot of research and market knowledge.
Disadvantages of Contrarian Investing
It takes a lot of curiosity and independent thinking to develop a contrarian opinion, as well as the time to investigate how specific stocks, larger stock sectors, or even the market as a whole trade.
It takes a certain amount of courage on the part of contrarian investors to hold with an unconventional opinion, especially if they have to wait a while to find out whether their theory is accurate. Investors who pursue a contrarian strategy must have the patience and resources to wait, especially given the possibility of some short-term underperformance.
Investors must be at ease with this kind of risk since there is an opportunity cost associated with locking money up in a contrarian strategy that may take months to pay off.
Given the time and effort necessary to establish reliable contrarian hypotheses, contrarian investing is also less reachable for most investors than other investment techniques. The chance to disprove other investors is alluring, but timing the buying and selling necessary for the contrarian strategy is challenging.
Famous Contrarian Investors
Although Warren Buffett is known for being a value investor, a large portion of his investing strategy is also contrarian. Buffett has amassed his riches by effectively identifying opportunities in the stock market, and his stock selections are extensively examined for their legitimacy and long-term investment potential.
Buffett has still warned investors against getting sucked into the pitfalls of any specific investment strategy: "Don't get caught up with what other people are doing," he has advised. "Being a contrarian isn't the trick, but following the crowd isn't either," the speaker said.
The Big Short by Michael Lewis has a major character who has emerged as the face of risk-taking investing. One of the few investors who properly forecast a bubble in the subprime home market was hedge fund manager Michael Burry. Similar to Burry, prominent professional money managers and hedge fund managers like Bill Ackman, George Soros, Ray Dalio, and Marc Faber have achieved fame for their contrarian wagers.
Recent history also demonstrates a divergent opinion that eventually won out. Early in 2021, amateur traders on social media became interested in a collection of equities that had lost favor with professional investors. So-called meme stocks like GameStop and AMC Entertainment saw enormous gains very rapidly.
The fundamentals (sales and earnings) for these companies eventually couldn't support the greatest prices these stocks experienced, and they later plummeted again. Nevertheless, some traders made money off of what first seemed to be a contrarian thesis.