What is Contrarian Investing?
It is a type of stock trading where in one attempts to invest in a falling market and sell stock in a bullish market. Contrarian investor is one who takes a stock position against the opinion of majority and profits from it. Her opinion is contrary to the conventional wisdom.
In stock trading majority of investors follow a herd mentality. When a stock market is continuously rising majority of investors become frenzy and keep buying continuously. When the market starts falling, majority of investors become panic and oversell, making the stock market dive down.
In a frenzied buying, the stocks become over valued. That is the time, when the bearishness is not evident, the smart money slowly withdraws from the market, selling all their stocks. This is called distribution.
Similarly in a panic selling, when the stocks become undervalued and attractive, accumulation of stock begins. The smart money slowly builds their stock position, even when the gloom still remains.
All the trading and investing methodology are usually trend following. If you are a beginner my advice is to stick to it and not deviate from it.
Trend is your friend. Trend is your friend till the end. Always follow the trend.
Investing contrary to the trend requires contrarian investor to be proficient with Technical Analysis and Fundamental Analysis. You have to understand the cycles of the market, good with Fibonacci and other Support and Resistance. You should have studied the technicality of the related Indicators and their usage.
Experience tells you when the trend is probably ending.
Commonly used indicator for investment decision is volatility indexes like VIX. VIX by tracking the prices of financial options, gives a numeric measure of how pessimistic or optimistic major market players are. A low number in this index indicates a prevailing optimistic or confident investor outlook for the future, while a high number indicates a pessimistic outlook.
Other indicators used are Stochastics, RSI and MACD. An understanding of Elliot wave helps you a lot in trading.
This type of investing is akin to value investing, since it focuses on buying under priced valuable stocks.
Warren Buffett a famous investor, believes that the best time to invest in a stock is when shortsightedness of the market has beaten down the price.
In my trading I make many contra trades when they present themselves to me. Here is an example of a trade I have taken when the trend is still down and change of trend is not established.
As you can see in graph above the trend is still down. I have taken the trade before the prices have crossed the Trend Line.
What are my supporting features to take the trade against the trend?
Stochastics, RSI and MACD Histogram – all are showing Divergence. All are giving Buy signals. And volume is increasing.