Contrarian Investing: A Beginner's Guide to Profiting Against the Crowd

A contrarian is an individual who acts in opposition to the majority. In terms of investing,Investing: A Beginner's GuideCFI's Investing for Beginners guide will teach you the basics of investing and how to get started. Learn about different strategies and techniques for trading 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 marketBullish and BearishProfessionals in corporate finance regularly refer to markets as being bullish and bearish based on positive or negative price movements.  A bear market is typically considered to exist when there has been a price decline of 20% or more from the peak, and a bull market is considered to be a 20% recovery from a market bottom. and opportunities to sell in a bull market.Bullish and BearishProfessionals in corporate finance regularly refer to markets as being bullish and bearish based on positive or negative price movements.  A bear market is typically considered to exist when there has been a price decline of 20% or more from the peak, and a bull market is considered to be a 20% recovery from a market bottom.

An Equity Research AnalystEquity Research AnalystAn equity research analyst provides research coverage of public companies and distributes that research to clients. We cover analyst salary, job description, industry entry points, and possible career paths. can use a contrarian strategy to look for assets that have a bearish prevailing market sentiment, and use Business Valuation Methods and Financial Modeling to evaluate if the stock is undervalued.

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Background

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 stockStockWhat is a stock? An individual who owns stock in a company is called a shareholder and is eligible to claim part of the company’s residual assets and earnings (should the company ever be dissolved). The terms "stock", "shares", and "equity" are used interchangeably. prices to extremes, by overstating or understating risk and returnRisk and ReturnIn investing, risk and return are highly correlated. Increased potential returns on investment usually go hand-in-hand with increased risk. Different types of risks include project-specific risk, industry-specific risk, competitive risk, international risk, and market risk.. Using a mixture of both Long and Short Positions,Long and Short PositionsIn investing, long and short positions represent directional bets by investors that a security will either go up (when long) or down (when short). In the trading of assets, an investor can take two types of positions: long and short. An investor can either buy an asset (going long), or sell it (going short). 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 biasBehavioral FinanceBehavioral finance is the study of the influence of psychology on the behavior of investors or financial practitioners. It also includes the subsequent effects on the markets. It focuses on the fact that investors are not always rational 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.

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Five Famous Contrarian Investors

Here are five famous investors who used contrarian trading in their investment process:

1. Warren Buffett – American investor, philanthropist, and CEO of Berkshire Hathaway (read why Warren Buffett dislikes EBITDAWarren Buffett - EBITDAWarren Buffett is well known for disliking EBITDA. Warren Buffett is credited for saying “Does management think the tooth fairy pays for CapEx?")
2. Jim Rogers – American investor, chairman of Rogers Holdings and Beeland Interests Inc., and co-founder of Quantum Group of Funds with George Soros
3. Marc Faber – Swiss investor and Director of Marc Faber Ltd, an investment advisor and fund manager
4. Bill Ackman – American Investor, philanthropist, and founder and CEO of Pershing Square Capital
5. George Soros – Hungarian investor, philanthropist, and founder and chairman of Soros Fund Management

Additional Resources

Thank you for reading this CFI guide to contrarian investing.  Check out these FREE resources to learn more about Trading & InvestingTrading & InvestingCFI's trading & investing guides are designed as self-study resources to learn to trade at your own pace. Browse hundreds of articles on trading, investing and important topics for financial analysts to know. Learn about assets classes, bond pricing, risk and return, stocks and stock markets, ETFs, momentum, technical. Also if you are looking to advance your career you should take a look at Business Valuation Methods Course, part of the FMVA™ CertificationBecome a Certified Financial Modeling & Valuation Analyst (FMVA)®CFI's Financial Modeling and Valuation Analyst (FMVA)® certification will help you gain the confidence you need in your finance career. Enroll today!.

Here are some other articles on relevant terms:

• Value InvestingStock Investing: A Guide to Value InvestingSince the publication of "The Intelligent Investor" by Ben Graham, what is commonly known as "value investing" has become one of the most widely respected and widely followed methods of stock picking.
• Risk and ReturnRisk and ReturnIn investing, risk and return are highly correlated. Increased potential returns on investment usually go hand-in-hand with increased risk. Different types of risks include project-specific risk, industry-specific risk, competitive risk, international risk, and market risk.
• How to Read Stock ChartsHow to Read Stock ChartsIf you’re going to actively trade stocks as a stock market investor, then you need to know how to read stock charts. Even traders who primarily use fundamental analysis to select stocks to invest in still often use technical analysis of stock price movement to determine specific buy and sell, stock charting
• Pessimist vs. Optimist InvestorsPessimist vs. Optimist InvestorsDifferentiating between pessimist vs. optimist investors is best done by using the phrase “a pessimist is an optimist with experience.” An optimist is hopeful and confident that things will turn out for the better. On the other hand, a pessimist always keeps in mind the possibility of the worst outcome.
• Financial Modeling and Valuation Analyst (FMVA)™ CertificateBecome a Certified Financial Modeling & Valuation Analyst (FMVA)®CFI's Financial Modeling and Valuation Analyst (FMVA)® certification will help you gain the confidence you need in your finance career. Enroll today!