Contrarian investing is a way of investing based on the psychology of going against the crowd. In this strategy an investor looks for points of maximum exuberance or despair and feels a greater disconnect between the sentiment and the fundamentals in reality. The investor finds the point where the majority is overreacting to the situation and believes the ground reality is very much different.
Contrarian investing can work in both bull and bear markets. In a bull market the investor can look for shorting opportunities in stocks which are being priced in a bubble valuation. The extreme optimism can be used here as a shorting opportunity. In a bear market the investor can look to buy good stocks at discounted price. When the tides returns the crowd turns and prices, turnaround very rapidly and give greater returns.
For example, due some general economic factor an industry is facing a crisis and the
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It needs good analysis of the underlying sentiment and careful research of the investment horizons in which the investor is finding opportunities. Analysis of the rational behind opportunity and the risk-reward ratio needs to be done carefully. Instinct should not become a basis for opportunity.
Some contrarian Investment Strategies:
High Dividend Stocks
Another example of a simple contrarian strategy is purchasing stocks having high dividend yield. This involves buying stocks that have high dividend yields. This may not be due to hike in dividends but rather due to fall in share prices due to reasons like difficulties in company or there is a low point in their business cycle.
Shorting Overvalued Stocks
Another contrarian investing strategy, although more dangerous, is shorting overvalued stocks. It has been seen that overvalued stocks sometimes continue to see run-ups due to over-optimism. Short sellers tend to go long in these kinds of stocks on belief that these stocks would eventually crash.
Contrarian vs. Value