Behavioral finance FAQ / Glossary (Contrarian)

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Dates of related message(s) in the
Behavioral-Finance group (*):
Year/month, d: developed / discussed,
i: incidental

Contrarian / contrarianism


02/12i - 03/8i,9i - 04/4i,7i -
05/1i,12i - 08/6d
+ see
consensus, mimicry

The crowd has biases
that can make the crowd's ship sink.

Bravery is needed to go against the sea of conformity.

But pure bravery can also have its biases
and the brave's lifeboat might sink in the same sea.

Definitions

1) A contrarian tends not to accept the conventional wisdom.

He/she is usually seen as a mental rebel, a nonconformist (see conformity),
a resistant, a dissenter.

2) The term is used mainly to categorize a type of investors.

A contrarian investor tends to behave against the market consensus
(see that word) or the current market behavior.

This is because a contrarian considers that:

The market consensus (common expectations) is based more

on mimicry than on objective analysis,

Such a consensus is often biased and bring wrong

expectations, thus asset mispricing.

The market tends to react wrongly to events.

A correction of that mistake strikes as soon as smart

investors understand it.

A value related attitude?

Or just a difference of sentiment?


Contrarian investors are sometimes seen as "value investors".

There are (debatable) similarities:

Contrarians tend to buy neglected stocks, preferably after a market fall
and when everybody is pessimistic.

It can thus be said that they look for cheap assets like value
investors do
.

Of course they also tend to sell assets which everybody is hot about..

But there are also differences:

* Contrarians operate against the trend
   and the general opinions.

* Value investors focus more on fundamentals than
   on trends and opinions.

Value investors do not evaluate all neglected stocks as cheap (value stocks),

Also, market falls and general pessimism do not mean systematically hidden
value (and fast price recovery).

How contrarians behave, practically

Picking fruits that most other pickers don't pick.


There are many ways to play the market game (see "styles").

The two extreme - and opposite - ones are to be a follower / noise
trader or to be a contrarian.

In practice, a contrarian investor tends to:

Invest against the trend (see that word)...

...maybe not always, but at least when he considers that the trend
magnitude and duration became excessive and the market sentiment
irrational, thus stocks are "oversold" or "overbought".

Prefer neglected stocks (value stocks), which he deems underpriced
    by the market,

Generally, analyze and interpret events differently,

And make opposite investment decision than most other players...
    before those investors, on his own judgment, will "understand their
    mistake".

Is it OK to be a contrarian?

Visionary or left behind?

To be a rebel has sometimes its good aspects, it can even be necessary
to act like one.

But to what extent be a rebel ? is it OK against everything all the time?

A) Some virtues of contrarian investing

Avoiding the rush hour jam...

One good point about contrarian investing is that it is usually advisable
to be wary of quasi-unanimous consensuses,

They are inspired more often by herd mentality than by thorough information
gathering and objective analysis.

Those unfounded consensuses can decrease or revert
at any moment, creating a market backlash.

Also contrarians who make long term investment may be
right not to follow the current trend.

Undervalued stocks (see "value investing"), with poor market
performances in previous years, tend often (albeit not always)
to outperform expensive /overvalued stocks that were the
craze in that previous period.

Even so, a thorough analysis must be done to check what risk and
reward prospects to expect from those "value stocks".


Also, some investors wait that their price start to rise and to percolate
above a critical barrier, as an evidence that they will not stay
underpriced.

=> This is to be a contrarian with some ...aptitude at being a follower.

Such a double play deserves respect ;-)

B) Some risks of "naive" contrarian investing

Risking to be left alone in the garage
while the goodies are on the road.


Any oversimplified and hard-headed habit and heuristic has its risks and
drawbacks.

To do "naive" contrarian investing, by behaving systemically - we
might say blindly - against the crowd, has its own flaws:

Anti-conformity is not independence but reverse
    dependence
to the consensus.

To be a contrarian in all circumstances is the opposite extreme
attitude of recurrent mimicry.

It is a bounded heuristic also, as it bans further
analysis of what caused the market actions and
what will be the real consequences of the new event.


For example, as seen above, any distressed stock should not be
    taken systematically
as a "value stock".


More fact-finding / analysis is needed to see if it is
the case.


Also, even if most other players were mistaken, they might
     persist for a long time in their error instead of correcting them.

Then the contrarian can get ...contrary results.

As the saying goes, if you go against a market craze "you have
to stay solvent for a longer time than the market stays
irrational".


A similar risk is that the trend might have only "settled in"
     and still has potential.

In various cases, the other investors' mistake might have
been not to overreact but to under-react
(see underreaction),
which means that the trend still has steam.

Then the wise thing would be to go, not against it, but in its
direction, as those investors will adjust late by amplifying the
move.

C. What about half contrarians?

All what has been seen above can incite:

* Not to fall in an over-simple habit and heuristic,

* To stay independent-minded and pragmatic,

* To try to identify the real forces at work,

* To be a trend followers in some occasions
   and a contrarian in others
,

* To be an opportunist more than a dogmatic.

(*) To find those messages: reach that BF group and, once there,
      1) click "messages", 2) enter your query in "search archives".

 Members of the BF Group, please
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This page last update: 24/08/15  

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