Buying when most investors are buying and selling. When others are selling are two deliberate strategies used by contrarian investors to go against the current market trends. Warren Buffett, the CEO and chair of Berkshire Hathaway, is a well-known contrarian investor.
Investors who are contrarians think that those who predict an increase in the market. Only do so when they are completely invested and have no more purchasing power. The market is at its pinnacle right now. As a result, by the time someone predicts a fall. The market has already reached its peak and can only rise further.
Comprehending Contrarian Strategies in Stock Market
As the name suggests, contrarian investing is a method that entails defying the current state of investor sentiment. One can apply the ideas of contrarian investing to certain stocks, an industry, or even whole markets.
When others are pessimistic about the market, a contrarian investor enters it. The contrarian thinks there is an opportunity because the market or stock is worth less than it should be. Essentially, a lot of other investors’ pessimism has driven the stock price below its fair value.
And the contrarian investor will purchase that stock before the general mood shifts back and the share price rises.
Contrarian investor and author of Contrarian Investment Strategies: The Next Generation David Dreman claims that investors undervalue the profits of troubled firms, overreact to news events, and overprice “hot” stocks.
This overreaction gives opportunities for the contrarian investor to select inexpensive companies by limiting upward price movement and causing precipitous losses for “hot” firms.
Particular Points to Remember
When the stock price has rebounded and other investors start focusing on the firm, contrarian investors frequently seek troubled equities and sell them. The foundation of contrarian investing is the notion that following the herd, which has the ability to steer the market, is not a wise way to Invest your money.
If the general positive feeling in the markets turns out to be accurate, however, and the market rises even after contrarians have sold their holdings, then this sentiment might result in lost profits. Similar to this,
if market sentiment stays negative, a cheap stock that contrarians are pursuing as an investment opportunity could continue to be so.
Value Investing versus Contrarian Investing
Since both value and contrarian investors seek for firms whose share price is less than the company’s fundamental worth, contrarian investing and value investing are related.
Value investors typically think that the market overreacts to both positive and negative news, which leads them to conclude that short-term stock price fluctuations don’t reflect a company’s long-term fundamentals. What is fundamental analysis? One technique for figuring out a stock’s fair market value is fundamental analysis.
Value and contrarian investing are similar in that they both seek for cheap stocks to benefit from by interpreting the mood of the market.
Investors Who Oppose the Market: Examples
Warren Buffett is the most well-known illustration of a contrarian investor. One of his most well-known sayings, “Be fearful when others are greedy, and greedy when others are fearful,” encapsulates his contrarian investment philosophy.
During the peak of the 2008 financial crisis, Buffett advised investors to purchase American equities as the markets plummeted amid a surge of bankruptcies. He bought stocks in American corporations, such as investment bank Goldman Sachs Group, Inc. (GS), as an illustration.
After a decade, his counsel turned out to be accurate. The shares of Goldman Sachs had increased by almost 239% from 2008 and 2018.
Michael Burry, a former neurosurgeon who now runs hedge funds in California, is another illustration of a contrarian investor. In 2005, Burry came to the conclusion that the subprime market was overheated and mispriced.
His hedge firm, Scion Capital, made money by shorting the riskiest segments of the subprime mortgage market. Michael Lewis wrote a book based on his incident called The Big Short, which was later adapted into a film.
A contrarian investment technique has significant disadvantages that investors should be aware of before using it. Finding cheap stocks may be difficult, and contrarians usually devote a lot of time investigating different industries and firms in order to identify good investing possibilities.
Merely acting in opposition to the emotion of the market will not be sufficient. To effectively determine a security’s inherent worth, contrarians need hone their fundamental analytical abilities.
There may be times when contrarians’ investments underperform. It might take a long time for a cheap stock to start making money. The contrarian investor might have to bear paper losses on their assets in the interim.
A contrarian investment approach is one that seeks for profitable trades that deviate from the mood of the market. For instance, the contrarian investor will be pessimistic and seek for opportunities to sell if the market is bullish.
On the other hand, the contrarian is bullish and will search for opportunities to purchase if the market is negative. The phrase “deep value investing” is sometimes associated with wealthy contrarians who choose their stock holdings based on their assessment that a specific business is trading at significant discounts to its intrinsic or book value.
These millionaires search for businesses whose stock values have been sharply and unjustly reduced by the market. Subsequently, they will purchase substantial shares in these businesses, hoping to benefit in the long run from rising share prices.
