A contrarian is an individual who acts in opposition to the majority. In terms of investing, a contrarian investor is someone who trades against prevailing market sentiments. When the market buys, the contrarian sells, and vice-versa. Contrarian investors look for opportunities to buy in a bear market and opportunities to sell in a bull market.
The idea is that behavioural bias during large swings in the market may lead to mispricing of some securities. Exaggerated optimism or pessimism can drive stock prices to extremes, by overstating or understating risk and return. Using a mixture of both Long and Short Positions, contrarian investing is similar to value investing, as both methods look for companies mispriced by the market.
Characteristics of Contrarian Investing
Recessions can be a good time to invest – 10 years after the housing bubble recession, the S&P 500 grew close to 200%. Entering into a long position when others are pessimistic about the market is a very difficult thing to do. However, in the words of Warren Buffett, “be greedy when others are fearful”. Being able to identify the behavioral bias of others, and avoiding falling into the same fallacies yourself, is key to sound value investing.
Long-term Investment Horizon– if all positions are analyzed with the long-term in mind, volatility and short-term market swings are almost negligible, as the time horizon extends far past the short-term. Hence a longer-term investment horizon can be beneficial for contrarian investors.
Choose companies with strong financial fundamentals– The intrinsic value of a company is often masked by market swings and negative press. However, a company with strong fundamentals will usually prevail against temporary market sentiments and its stock price will inherently reflect that in the long-term.