A contrarian investor is one who goes against the dominating trend in the market. These investors look to profit from the market by disagreeing with what the majority of the market sentiment is showing.
A contrarian investor believes a market has mispriced a stock and they look to exploit these stock mispricings by going against the crowd. For instance, when a stock has been heavily sold off and confidence is poor, a contrarian investor will buy these oversold stocks at low prices. These investors believe the market has overreacted to a result or news and this causes a chain reaction where other investors see the poor performing stock and also want to sell out driving share prices even lower. Contrarian investors will see this stock as good value at these levels as it is below its intrinsic value. Once this under-priced stock improves, a contrarian investor will sell the position even if they are in bull market.
Contrarian investors have a long-term horizon so they are not concerned with market movements in the short term. This is similar to value investing where investors look for under-priced stock and hold them long term. Contrarian investors look for stocks that are fundamentally strong and believe the stock will perform long term.
Examples of contrarian investing
The market was heavily sold off March last year due to the uncertainty of the economy from the impacts of COVID-19. The S&P/ASX 200 closed at 4546.04 on the 23th March 2020. A contrarian investor would have been buying stocks at this level compared to what the rest of the market was doing. The S&P/ASX 200 has rallied 48.70 % from the March 2020 lows so it would have been a profitable decision.
Risks of contrarian investing
Stocks can be fundamentally sound but if the market doesn’t believe it in, there will not be any share appreciation in the stock. Contrarian investors may need to wait a long time before a stock recovers – assuming that it does. When the broader market is in a bear phase then this will pull down all stocks. Also, if a market is in the bull phase than this will pull up all stocks and the contrarian investor may have missed out on further gains on the stock.
Lauren Hua is a private client adviser at Fairmont Equities.
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