
Some people don’t like to with the flow. They go against it, like the people who use contrarian investing. These investors go to the opposite side of the prevailing market trends. Hence, they sell when most are buying, and they buy when most are selling. People think that the market is going up because they are fully invested and do not have more purchasing power. Now, the market may be at a high, and there may be a prediction that the market will decline later. In this case, the market has no way but up in because they already sold out.
Tell me more about contrarian strategy.
Contrarian investors go against investor sentiment at a given time frame. This principle is also applicable to individual stocks, specific industries, and even markets as a whole. If you enter the market even when most do not feel good about it, you are considered someone who uses the contrarian strategy. The belief is that a market’s or a stock’s value is lower than the intrinsic value. So, this is seen as an opportunity. On the other hand, people may sometimes feel negative about a stock. Their collective pessimism drives the price lower than how it should be. So, contrarian investors buy before more sentiment and share prices go back.
David Dreman and the contrarian strategy
David Dreman is a contrarian investor who says that investors tend to overreact to new developments. They overprice stocks that are in at the moment. On the other hand, they underestimate distressed stocks earnings. If people overreact like this, there will be lesser upward movement. There will be a decline in the stocks that are “in.” Thus contrarian investors get to choose underpriced stocks.
Contrarian investors think differently. When most would prefer those stocks with a good reputation, they choose the distressed ones. They do this to sell them later when the share price recovers and investors slowly see the company. Have you heard of the herd instinct? It speaks a lot about the contrarian strategy, and this herd instinct somehow controls the market direction, and it is not too practical to use as an investing strategy. But what happens if the bullish sentiment turns out to be true? You will miss out on gains. There will be market gains because contrarians sold their positions. The same logic is true with undervalued stocks. Contrarian investors pick these because they see an opportunity. But again, they can remain undervalued if the market sentiment turns out that it is actually bearish.
How different is it from value investing?
Contrarian investing has many similarities with value investing. They are similar because they both look for stocks with a share price lower than the company’s intrinsic value. Value investors also think that the market tends to overreact to news. Hence, they think that short-term stock price movements do not match the long-term fundamentals of a company. These two strategies look for undervalued securities so they can get profits on their current market sentiment reading.