While investing is more popular and accessible than ever, and investors have an endless library of information at their fingertips, stock prices still move based on emotion, and the herd mentality that dominates Wall Street isn’t going away any time soon. Bulls and bears react to news and financial results quickly and emotionally, and these so-called “animal spirits” are often the driving force behind the gains and losses of everyday investors.
Investors who are able to remain objective and avoid making emotional buy and sell decisions based on news and sentiment, therefore, stand to do well in the long term by staying one step ahead of the market. These sorts of investors are called contrarians.
What Is Contrarian Investing in Simple Terms?
In the simplest of terms, contrarian investing means acting in opposition to dominant market sentiment. If everyone is buying, a contrarian sells, and vice versa. In practice, contrarian investing is a bit more complicated, but it often boils down to buying undervalued stocks in unpopular industries while selling overvalued stocks in popular industries.
Contrarian investing is a medium-to-long-term investment strategy that involves conducting research into which businesses, industries, and sectors may be incorrectly valued due to market sentiment, media fervor, and other aspects of Wall Street’s herd mentality. A contrarian investor attempts to take advantage of these inefficiencies by buying unpopular stocks while they are cheap, then selling them when the market eventually realizes their value and they move back into favor—which doesn’t tend to happen overnight.
A contrarian could also use put options or short selling to bet against overvalued stocks, but these instruments are more commonly used by shorter-term traders, while contrarian investors usually have longer time horizons of a year, several years, or more. For this reason, longer-term contrarians often buy and sell stocks directly rather than shorting or using derivatives.
What Are the Characteristics of a Contrarian Investor?
While different contrarians focus on different parts of the market and may use different stock-picking strategies, most have the following traits in common:
- They believe markets are emotional and irrational and do not price assets efficiently.
- They spend a lot of time doing research and looking for underpriced stocks (much like value investors).
- They use fundamental analysis and avoid technical analysis.
- They stick to their strategy regardless of unexpected price movements.
- They tolerate short-term losses and are patient for long-term gains.
What Sorts of Investors Should Use a Contrarian Strategy?
To be successful with contrarian investing, an individual needs to have some level of market and industry expertise in addition to the time and attention necessary to conduct ongoing research and watch stocks regularly. Patience and objectivity are key, as a contrarian strategy can take a long time to pay off, and short-term losses must be endured without pivoting due to fear or greed.
In other words, seasoned investors who have extra money they don’t mind tying up for several years and who have a good understanding of the economic cycle and how it affects asset prices across industries could be good candidates for a contrarian investment protocol.
More casual, hands-off investors would likely do better with a passive buy-and-hold approach, using dollar-cost averaging to invest in several well-diversified ETFs at regular intervals over time.
What Are the Advantages of Contrarian Investing?
One of the primary advantages of contrarian investing is only purchasing stocks with a considerable margin of safety—in other words, stocks that are trading below their intrinsic value. The larger an investor’s margin of safety on any stock they buy, the less they stand to lose, and the more they stand to gain, at least in the long term.
Because contrarians only buy stocks that are “on sale” due to negative market sentiment and sell stocks when they are “overpriced” due to popularity and positive sentiment, their portfolios tend to outperform benchmarks over the long term (e.g., several years).
What Are the Disadvantages of Contrarian Investing?
Contrarian investing is risky and difficult to do well, meaning it isn’t ideal for everyone. Even for an investor who is able to research and value stocks correctly and maintain a contrarian strategy in the long term without being swayed by short-term losses, this investing style can come with some downsides.
Contrarian investing takes a lot of effort and market watching, and it can take a very long time before a contrarian portfolio begins to significantly outperform the market. Buying unpopular stocks means taking on risk, and there’s never a guarantee that the market will eventually come around and realize the worth of an undervalued security. A single piece of news or a disappointing earnings call can be enough to send an already struggling stock plummeting, and contrarian investors need to be able to stomach these losses without straying from their strategies.
Examples of Well-Known Contrarian Investors
- Warren Buffet: Buffet, perhaps the most famous investor of all time, is both a contrarian and a value seeker. His advice? “be fearful when others are greedy and greedy when others are fearful.”
- George Soros: Many consider Soros the greatest contrarian investor of all time. He famously shorted two currencies—the yen and the pound—and in doing so made $2 billion and “broke the Bank of England.”
- Michael Burry: Michael Burry’s contrarian strategy was immortalized in The Big Short, a 2015 film that chronicled the fund manager’s famously profitable bet against the over-inflated housing and mortgage markets of the late aughts.
- David Dreman: Dreman is the chair of Dreman Value Management, a notoriously contrarian investment firm, and the author of the 2012 book, Contrarian Investment Strategies: The Psychological Edge, along with three other titles on the subject.
