I have started to notice recently what a contrarian person I am. Whenever the majority of my friends or the public hold one opinion, I naturally look for the other side. Why do they think that? What are they missing?
I realise that, aside from making me less popular at dinner parties, this attitude comes from decades of investing. Some of the best stocks I have bought have been when everybody else was doing the opposite. As Warren Buffett said, be “fearful when others are greedy, and greedy when others are fearful”. I couldn’t agree more.
Contrarian investing
Just to clarify, a contrarian investor is one who goes against the majority opinion. If everyone is panicking because of some bad news for example, a contrarian investor might use the opportunity to buy shares rather than sell.
But being a good contrarian investor is not just about doing the opposite of what everyone else is doing every time. It is about considering the other side and analysing the real impact or potential impact of what is driving the price.
The truth is that while fundamentals move shares prices over the long term, in the short (and even medium) run it is expectations that drive shares. Positive and negative expectations bring about buying and selling. While this can be trouble for fundamental investors (the old adage, “the market can stay irrational for longer than you can stay liquid“, springs to mind), it also offers an opportunity.
Expectations can of course, often be exaggerated or even wrong. Indeed just about every psychological study into human nature and investing suggests that instinct is USUALLY wrong. Fear and greed drive the majority of people’s snap decisions.
So what do I look for?
Though there are no hard and fast rules that will always work, there are some good guidelines. Firstly, in any news story or company release, try to ascertain the truth behind it. Think about the consequences of what you are reading without emotion, and without being influenced by the style of writing from the source.
A company, for example, may say it is expecting a tougher trading environment this year. It will be telling you that to manage expectations. How bad exactly does it expect it to be? What will that actually translate to in its profits? What has the share price done because of the news? It may warrant a 5% drop, but does it warrant a 20% one?
Next, the best opportunities always come when fear is highest. When everyone is panicking. This usually means when some dramatic news has come out. See this news in context. It may hurt a company now, but will it hurt forever?
If oil prices plummet for a few months, for example, will that really be bad for oil companies going forward? Can we expect prices to recover eventually? Everyone else’s fear means the shares are lower than they should be. Buy!
One of the hardest parts, however, is knowing when to buy and when to sell. Fear can carry on driving a price lower even after you have bought. Likewise, although selling may have been exaggerated, the news can still be negative for a company. Judging this, unfortunately, takes practice and common sense.
