Friday, March 10, 2017

How to be a successful Contrarian Investor

To be a successful contrarian investor, you need to follow Buffett's simple philosophy: Be greedy when others are fearful and be fearful when others are greedy.

In other words, a contrarian investor will look for opportunities to buy when there is blood on the streets and experts are advising that the economy will get a lot worse before it gets any better.

Likewise, a contrarian will look to book profits when the stock market is rising to new highs and everyone and his brother-in-law is offering tips on what to buy.

Simple, right? But almost impossible to follow when it is your own money on the line. The human brain seems to function irrationally when monetary transactions involve uncertain outcomes - like in the stock market.

Doing the exact opposite of what a consensus view is suggesting requires training and discipline. Knowledge of basic technical analysis tools can be of great help.

Here are some typical contrarian signals that even novice investors can learn to spot:

1. A stock's price is touching new highs, but volumes are falling
2. An index keeps rising but technical indicators are flat or falling
3. A stock's price touches a new low, but technical indicators touch higher bottoms
4. Widening distance between a stock's price and its 200 day EMA
5. An index is moving up but the number of declining stocks is more than the number of advancing stocks

The above list is not meant to be exhaustive - just indicative. 

Being able to spot certain chart patterns that indicate the opposite of what the price action is suggesting can also help a lot. E.g. a stock's price is falling but trading within a 'falling wedge' pattern indicates a likely breakout upwards.

Similarly, if a stock's price is rising but trading within a 'rising wedge', it is a signal for a correction.

Needless to say, buying or selling a stock just based on price patterns and contrarian indications is not enough. Adequate research about a company's financials and investment-worthiness should be carried out before taking any buy/sell decisions about its stock.

Also, refrain from buying or selling just because a stock has risen 20% or an index has fallen 20%. A rising stock can rise even higher, and a falling index can fall even lower.

How does one know beforehand how far a falling index will fall? What if it falls first, then rises again before falling even further?

One really can't tell beforehand. Again, some knowledge of technical analysis can be helpful. 

Those who have been regularly reading my posts know about long-term 'support-resistance' levels and Fibonacci retracement levels - and the roles these levels play time and again.

Most important of all, to be a really successful contrarian investor, you need to have oodles of patience. Waiting for the right price to buy or sell - without trying to catch the exact market bottom or top - will add several percentage points to your eventual returns.


saurabh said...

Very Nice post sir.. you only realise the importance of this after being in the market for some years and paying a substantial tuition fee to the market..

Subhankar said...

Thanks for your comments, Saurabh.

I am not ashamed to confirm that I've paid my fair share of tuition fees!

saurabh said...

yes sir, thats the best part.. in the long run, even after paying tuition fee; one makes enough from the market if one follows a disciplined strategy.. have been following your blog for some years now and would take the opportunity to thank you for all the learnings..