Contrarian investing

If you tend to do the opposite of everyone else, contrarian investing could be for you. We explain why, and outline the pros and cons.

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Ceri Stanaway

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Are you the kind of person that loves disrupting easy conversations by throwing in an opposing view? Who turns their lip at the idea of following fashion trends, and wouldn’t be caught dead reading a copy of the latest Sunday Times bestseller? If so, you could be a natural contrarian investor. Read on to find out more about this counter-intuitive investment style and if it would suit you.

What is contrarian investing?

Contrarian investing is an investment style where the investor deliberately goes against the tide. The contrarian investor buys when others sell, and sells when others buy.

Contrarian investing is all about seeking out stocks which others have oversold, or betting against “hot” stocks that have been overhyped and have sky-high valuations.

Contrarian investors believe that market movements are often an overreaction.

For example, a terrible bit of PR can drive a price so low that it over-exaggerates the negative traits of a business. On the flip side, hype around a stock can lead to absurdly high valuations that will drop down eventually.

Is contrarian investing active or passive?

Contrarian investing is a form of active investing. Active investors aim to beat the market, rather than simply keep pace with it, by looking out for investments that they think will do better than average and buying and selling accordingly.

With passive investing, an investor simply tries to replicate an index (such as the FTSE 100) and hold it for a long time. The approach minimises buying and selling in order to save costs.

How does contrarian investing work?

To make contrarian investing work, first you have to have a good grasp of the majority or “consensus” view. A contrarian investor would establish how most investors would behave given the way the stock market is moving. And then do the opposite.

For example, if a stock market sector is currently unpopular among most investors due to stagnant growth, a contrarian investor might see this as a sign of good potential growth in the future and choose to invest heavily. If and when they are proven right, and most investors get excited about the sector again, they might choose to sell on the basis that the growth of their investments is going to slow down soon.

This type of investing relies on a few things:

  • A tolerance for uncertainty. Contrarian predictions aren’t always proven right and, even if they are, this can take some time.
  • A willingness to accept short-term losses.
  • A “contrary” nature. You have to be pretty tough and resilient to go against the grain of what the investment zeitgeist might be telling you.

What are the advantages of contrarian investing?

Like any investment strategy, its advocates will tell you the main advantage of contrarian investing is the potential for higher returns.

If you buy stocks at bargain basement prices, and short the market right before a huge crash, you obviously stand to make significant gains. And, in theory, if you regularly buy stocks that are out of favour, this means that the chances of you buying over-valued stocks is lower. So there’s an argument that even when you get it wrong, there’s a safety-margin built in.

When it works, there may also be an element of smug personal satisfaction to be gained from being proven right against the odds.

What are the disadvantages of contrarian investing?

First off, contrarian investing is a lot of effort, and requires a very creative mindset. Not only do you need to thoroughly understand prevailing market sentiments, you then have to spend time and brainpower wheedling out the opportunities to buck the trends.

Then, assuming you have the time and the right mindset, you need the dedication to stick to your guns and stay on the sidelines, whilst everyone else’s portfolios are on the up. Contrarian strategies can take some time to be proven right, and you could lose money in the short term.

And finally, like any investment strategy, it may not work. You could miss out entirely on expected returns if market sentiment shifts in a way you hadn’t anticipated.

What are the alternatives to contrarian investing?

If contrarian investing feels a bit too counterintuitive for your mindset, there are plenty more styles to consider embracing. Not everyone agrees on the number of different styles there are, and you may hear them referred to by different names. But some of the most well-known investment styles include:

  • Value investing: investors seek out unfashionable bargains which they believe are trading at a low price relative to their true value. There is some alignment between value investing and contrarian investing. Both approaches look for stocks that have a lower price than they should have.
  • Growth investing: this focuses on fashionable companies that are expanding quickly and posting strong profits. Growth investors expect these companies to have high future earning potential – or growth.
  • Quality investing: investors seek to own a share of businesses that will stand the test of time. This investment style is built on the concept that quality businesses are more likely to deliver quality returns.
  • Momentum investing: investors buy stocks in companies that have already gone up, on the basis that they will continue to do so.

Examples of contrarian investing

Investing during a recession

Investing during recessions is a hallmark of contrarian investing, as many investors pull out of the stock market during such periods.

After the market bottom in 2009, following the financial crisis which began in 2008, the S&P 500 (an index tracking some of the USA’s biggest companies) had risen nearly 300% over the next 10 years.

Ditching overhyped stocks

Tesla and Apple are some of the most expensive shares on the stock market, and some believe mass retail investment to have massively inflated their valuations at times. Tesla, for example, hit a high of more than US$400 a share in November 2021, after a period of rapid growth.

While many investors might pile on such bandwagons in the believe that growth will continue, bolder contrarian investors might see trends like this and decide to”short” the stocks in question – meaning they’d make a bet that the stock will in fact fall.

Buying stocks that have plummeted

Sometimes stocks sink in value in response to a particular trigger, but the underlying business is still the same as before. Contrarian investors might look at these stocks, assess the fundamentals of the business and conclude that the businesses are, in fact, still worth investing in and that investors have sold off too much.

An example of this could be Boohoo. In mid 2020, the fashion brand saw its share prices plunge in response to a scandal around where and how its clothes were produced. Without getting political, this was more of a PR issue than it was an issue with the business (although you could easily argue the two are linked).

If contrarian investors had bought Boohoo shares immediately after the scandal broke, they’d have seen fairly rapid returns to nearly pre-scandal levels a few months later.

That said, investors would have had to be on their toes. Boohoo’s share price has dwindled subsequently, and as of mid 2023 was worth less than a tenth of its one-time high.

Where can I apply a contrarian investment strategy?

Applying a contrarian strategy involves seeking out and acting on specific opportunities. These can be at an industry level – construction, tech, or fashion, for example. But may also be at a company-specific level. As such you may want to look for a broker or investment platform that offers a range of investment types, including funds and shares.

Who are some famous contrarian investors?

  • Warren Buffett is probably the most famous investor with a contrarian streak, though some might regard him as primarily a value investor. He’s known for the phrase “be fearful when others are greedy, and greedy when others are fearful.” Buffett has long encouraged investors to buy stocks during downturns.
  • Michael Burry. Seen the Big Short? That film’s about Michael Burry and how he spotted the market crash in 2008. His hedge fund Scion Capital used this insight to short the market and made obscene profits.
  • Nassim Taleb is another famous contrarian, maybe not just in investing, although he may disagree. Taleb is known for advocating “tail-risk hedging”. He made a lot of money in the 2008 crash, and the hedge fund he’s associated with, Universa Investments, made a huge return during the market crash in March 2020 due to coronavirus.

Who is contrarian investing right for?

Danny Butler

Finder investing expert Danny Butler answers

Contrarian investing isn’t for the faint of heart. It’s not easy, by any stretch of the imagination, and relies on you being able to “time the market” as an investor. You also have to have the emotional resilience to hold when things look shaky and sell when you’ve made your profits (rather than get greedy).

If you’re after short-term gains (and we hope you’re not, as investing will rarely give them), then contrarian investing definitely isn’t for you. Contrarian investors dedicate time and effort to identifying opportunities where they believe that the consensus view on market movements is wrong. The hope is that, eventually, their decisions will reap rewards as other investors readjust their outlook.

This means that you have to be comfortable with uncertainty and with potential short-term losses. If you’re time-poor, and the idea of losing money would give you sleepless nights, a passive investment approach might be more up your street.

Pros and cons of contrarian investing

Pros

  • There is the potential for big rewards when you get it right
  • You have the opportunity to outperform the market
  • If you succeed in the face of adversity, this can be extremely satisfying.

Cons

  • Substantial time and effort is needed to understand the market and the opportunities to buck trends
  • You may have to wait for considerable time for your contrarian punts to pay off, and sometimes they may not
  • You’ll need to be resilient to stick to your guns in the face of opposing market sentiment.

Bottom line

Contrarian investing isn’t the most intuitive – or easiest – investment strategy to follow, as it involves doing the opposite to what most investors are doing. But with its risks comes the potential for reward, if you time things right, stick to your guns, and stay invested for the long term. Or, if you’re not sure it ticks all your boxes, find out more about alternative investment strategies.

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