Contrarian Approach to Stock Market Investing – A Short Note

Contrarian Approach to Stock Market Investing – A Short Note

Everyone can buy stocks. There’s no shortage of advisers in this business. It’s full of experts.

But instead of relying on tips, we could do our own research and analysis and if we do not have the time and/or do not want to take the effort, then we should invest in what we know better – and leave the stock market on its own.

We get trends – bears or bulls – when the herd mentality takes over. Instead of always being on the side of the herd, it might be safer to take an “opposite” stance.

I mostly hear people – how high will this item go? And their eyes fill with joy and there’s a tingling sensation of greed when the item does go up. But fear also takes over once the prices start to fall.

Thus, can we, at times, try to change the line of thought to “how low will it go”? Then it gives the buyer an idea where to buy – where the risk is low but not nullified as a stock might even go to zero!!!!

It is the old adage – buy low and sell high.

If we could mould ourselves and try to estimate how low a stock – preferably backed with fundamentals such as High EPS, low PE, positive Cash Flows, Huge Cash Balance, etc – could go, then it gives the investor a better chance of profit-making.

I would say it is a low-risk, low-profit strategy. Good for people with a risk-averse nature.

But again, only buying low will not guarantee success. Buying when prices are falling is a stance against the crowd. So if one could bravely do this and hold during the wave of fear – then one should be prepared to sell after a certain price or “target” is reached and when most of the crowd is buying with enthusiasm – again taking a stance against the crowd.

This is Contrarian Approach (only catch is that it might not as profitable when the market is in a huge bull run – where momentum trading could yield higher profits).

An alternative example, a bit crude, could also be explained with demand and supply. For example, during potato harvest time, a bumper crop results in huge supply and price falls (unfortunately, the farmer suffers); this could be compared to a bearish phase of the market where stocks are available at low price – huge supply but most people are reluctant to buy as they fear for more fall in prices. This is where the Contrarian buyer could buy and then wait for his/her stock to rise to a certain price or where his/her profit margin like 15% is reached.

During this period, some opportunists buy potatoes at low price and “hold” it in cold storage. After a few months, once potato supply is nearly exhausted, prices tend to rise (as there is demand) – that’s when the “holding” potatoes come into the market; this could be compared to a bullish phase of the market where stocks are flying – huge demand but again many people are reluctant to sell as they are greedy with expectation of further rise in prices. Here, the opportunists or risk-takers make profit – quite like the stock-trader who buys at low price and sells at a higher price instead of waiting for “more” possible gains. 

This is where the Contrarian sells his/her stock as price has risen to his/her “earlier planned” profit level. And then the Contrarian is again (preferably already) searching for items that are being discarded and being traded at low prices (and PE).

Would like to end on a contrary note though – one word of caution from 1884: No price is too low for a bear or too high for a bull (Anonymous).

I have tried to write a short summary on contrarian approach this time. For people interested in this topic will find better arguments in the following books.

Contrarian Investment Strategies: The Psychological Edge (2012) by David Dreman (who has written other books on Contrarian Trading too)

Contrary Investing for the 90's: How to Profit by Going Against the Crowd (1991) by Richard E. Band

The Art of Contrary Thinking by Humphrey B. Neill