Going Against the Grain: Contrarian Investing Guide

Photo of author
Written By Adeyemi Adetilewa

The world has recently been struck by something it could have never been prepared for—the COVID-19 pandemic. As a result, the markets have seen devastating effects and received crushing blows.

However, it has kicked off a flurry of different investment strategies—particularly, contrarian investing.

The devastating effects of COVID-19

The Coronavirus pandemic has affected the world’s economy in many ways. Citizens are required to stay at home (implementing remote work policies all over the world, if employees are lucky enough to have any).

Despite self-quarantine and social distancing laws being implemented to contain the spread of the virus, they have had crushing effects on people’s personal finances—particularly people who work in industries such as travel, entertainment, retail, education, and hospitality, to name a few. 

With work-from-home policies in place, some people are struggling to find new ways to make money and financially survive the pandemic.

However, others have turned to an investment strategy that plays well along the lines of the situation: contrarian investing. 

Easy Contrarian Investing Guide 101: Going Against the Grain

What is contrarian investing?

If you aren’t familiar with the strategy, contrarian investing refers to “going against the grain” in terms of market trades. Contrarian investing is a strategy of going against prevailing market trends or sentiment.

Contrarian investors intentionally go against the market trends by selling when others are buying and buying when other investors are selling.

According to contrarian investor belief, people only say that the market is going up when they are fully invested—implying that they have no more purchasing power.

In turn, when people predict that the market is going down, that means other investors have already sold—implying that the market can only go up from there. As a result, these contrarian investors enter when others are feeling negative about the market.

Instead of following the trends of the market, they look at the value of the asset and the market’s perception of that asset, creating opportunities for them when they see something undervalued. 

In simpler terms, the negative feelings that people have towards the market push stocks below their “potential” value. As a result, contrarian investors will buy a stock before the broader sentiment returns—before the share prices rebound.  

This strategy can be applied in many forms of investment, whether it be individual stocks, entire industries, or even whole markets.

Contrarian investors will often target stocks that are distressed and then sell them once the prices recover—when other investors begin targeting the company as well. 

In theory, contrarian investors are against the herd instinct mentality—an instance when individuals collectively act as part of a group or mob—expressing that the ability of the “herd” to take control of the market doesn’t make a good investment strategy.

However, this sentiment can backfire if the market trends prove true, potentially leading to market gains even as contrarian investors have already sold their positions. At the same time, distressed stocks that are targeted by contrarian investors as an investment opportunity can remain undervalued. 

Contrarian investing and value investing

Investopedia defines value investing as “an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value.”

In essence, value investors will actively look for stocks that they feel are being underestimated by the market. As a result, value investors believe that markets will often overreact to both good and bad news—meaning that a company’s long-term fundamentals aren’t relevant in the short run in terms of stock price movements. 

As you can see, value investing and contrarian investing have a few similarities as both strategies look for underestimated stocks.

However, many investors believe that there is a fine line between the two—that value investors look for inherent value in companies, while contrarian investors mainly go against the grain of market trends.

Easy Contrarian Investing Guide 101: Going Against the Grain

Much easier said than done

If you are thinking that contrarian investing may be the strategy, hold your horses. There are still a lot of things to consider before trying out this strategy.

First of all, herd instinct is called “herd instinct” for a reason. Human nature entails conforming with our fellow neighbours. Think about the last time you made a general decision—you probably asked yourself what other people would do in your situation.

Don’t blame yourself; it is generally a way that people make their decisions—they look at how others have behaved in those situations as emulating others’ behaviour can be useful in many areas of life.

Take choosing a restaurant as an example. Before people go to a certain restaurant, most check online reviews from previous diners as a quality check. 

It is a totally different thing when it comes to investing. As stocks become more popular amongst investors, the competition to buy increases, and as a result, stocks can often become overbought. The price is pushed higher, meaning you have to pay more—which, in turn, takes away from your potential return on investment.

Compared to the restaurant example given earlier, stock markets are more forward-thinking—future expectations are already placed into their price. If a stock priced for “perfection” only turns out “good,” the price is likely to fall. At the same time, if a stock is priced as a “disaster” and turns out to only be “kind of bad,” the price can rise significantly.

In essence, the share price is driven by comparing prior expectations and actual outcomes. 

I guess what I’m trying to say is that going against the herd can be extremely tough on your mental psyche. Most of the famous contrarian investors have put up big money before and came out on top. However, it is important to know that these investors did a fair amount of research to make sure that the trends were indeed wrong.

The price of a stock dropping doesn’t mean immediately putting out a buy order. Instead, find out why the price dipped and if the price drop is justified—this is the side of successful investors that not a lot of people see. 

Trying contrarian investing in different industries

As mentioned earlier, this style of investing can be applied to many industries. Here are a few to get you started: 

1. Oil stocks

Due to the COVID-19 pandemic, the global economy was put to a grinding halt. In the oil storage situation (the lack of storage for extra oil while companies continue to produce, all at a time when the demand is collapsing), the oil industry has taken a massive hit—with oil prices dipping to some of the lowest levels ever. Only a few industries have been hit harder than the oil industry. 

Unfortunately, it could take a while for the industry to recover. However, investors see a lot of business opportunities with the price dips. As the price continues to drop, more interest is generated amongst investors as they expect the price to bounce back, taking the oil stocks with them eventually. 

The biggest problem that oil industries face is that the oil company that investors put their money on has to survive through the crash and make its way to the other side—rebound.

2. Cruise stocks

Alongside the oil industry, the cruise industry is also hit by multiple coronavirus-related issues—ships haven’t left the deck since March, no one is allowed to travel, and people are afraid to be in an enclosed space with many others, to give a few examples.

Despite the optimistic predictions of these ships leaving the docks by mid-May, people are questioning if the industry altogether will survive. There’s no question that this industry won’t look the same for a while, but investors are looking at it as a new opportunity. 

The investor belief is that cruise customers will eventually come back (once they are convinced of its safety). However, it may take a while (with some people speculating that it could take years for it to return to normal). 

3. Airline stocks

Unfortunately, just like the cruise ship industry, the airline industry is going to feel the effects of the pandemic for some time to come. As a result, airline stocks have dipped more than half of their value as COVID-19 has absolutely destroyed the demand. 

Just like the previous two examples, contrarian investors are using this to their advantage. Relatively, the airline industry went into the dip relatively healthy, so most airlines should be able to recover properly—especially because of a U.S. government $50 million bailouts, allowing the industry to temporarily ride out the storm.

4. Bitcoin

For many years (despite the debate), people have considered bitcoin to be a “safe-haven asset,” meaning that in times of crisis, BTC would be a way out. 

Although many people have debated the case against BTC being a safe-haven asset recently due to the dip in bitcoin price, there are still a lot of cases that would say otherwise. Alongside the real-use opportunities that it provides, bitcoin is beginning to prove itself to be a worthy contrarian investment.

Compared to months ago (when COVID-19 was still making its way around the world), BTC has seen big spikes in the price—many people believe that it is only just beginning.

Easy Contrarian Investing Guide 101: Going Against the Grain

The theory isn’t enough: How do you become a contrarian investor?

Although you may have an idea of how contrarian investing now works, it is important to understand that merely having the investment philosophy is not enough—you have to embody it.

As mentioned earlier, it can be challenging to go against human instinct (to conform). It not only requires motivation, but it also requires patience and restraint. You have to be tough enough to endure short-term underperformance while you wait for the rest of the market to see the value you’ve identified. 

When it comes to contrarian investments, it is important to keep your emotions in check. It is easy to let excitement take over you once you see your investments build. That excitement can even lead to thrill and euphoria.

But what happens when the price dips again? It turns into fear, anxiety, and then finally, despair. Sometimes, the price will rise again, and the rollercoaster of emotions starts again.

As a contrarian investor (or even just an investor in general), you have to be prepared for the emotional battles that you’ll be facing. Not only that, but you also have to be smart about the way you invest.

In most cases, stocks hit rock bottom for a reason. They have little to no chance and recovery, and if you are not careful, you can fall into that trap. 

If you want to try your hand at contrarian investing, make sure that you are ready for anything—and that includes making mistakes and investing in the wrong assets.

Disclaimer: We are really happy to work with our sponsor, Paxful, today to share this information with you!

Disclaimer. The views and opinions expressed here are those of the authors. They do not purport to reflect the opinions or views of IdeasPlusBusiness.com. Any content provided by our bloggers or authors is of their opinion and is not intended to malign any organization, company, individual, or anyone or anything.

For questions, inquiries and advert placements on the blog, please send an email to the Editor at ideasplusbusiness[at]gmail[dot]com. You can also follow IdeasPlusBusiness.com on Twitter here and like our page on Facebook here. This website contains affiliate links to some products and services. We may receive a commission for purchases made through these links at no extra cost to you.

Share
Tweet
Share
Pin