Contrarian investment strategy can be defined as acting in a manner contrary to the conventional stock market wisdom at any particular time. It is a preference for fundamental analysis in picking individual stocks, while ignoring the overall trends in the market.
George Soros is among the most famous contrarian investors of our time. Along with Jim Rogers, he created the Quantum Fund based on a contrarian philosophy. The fund went on to give returns of about 4000% over a period of 30 years. The most famous contrarian move that George Soros made was going short on the British pound and earning US$1 billion in a single day in 1992. Rogersís famous contrarian bets were getting into the equity market in the early 1980s when most of investors avoided them and into the commodity markets in 1990s at the peak of the dot com boom.
In the conventional model, investors look favorably upon stocks that are rising in price and shy away from those stocks that are falling. This approach causes investors to overlook quality companies with prices that have fallen because of events or perceptions that are temporary in nature. Contrarians behave in a manner opposite to the majority and buy when stocks are falling in price. The philosophy behind it is that out of favor companies involve less risk, since purchase are usually made at the low end of valuation cycles.
Contrarian investment encompasses several themes such as picking up neglected stocks with strong asset values, under-owned sectors with high growth prospects, companies with latent earnings potential etc.
How to apply contrarian investment strategy
By focusing on stock selection: An investor should focus on fundamental analysis of a company rather than following the market trends. He should look for value hidden in the company and try to pick them up before others realise the potential locked in the company.
By changing the diversification strategy: A contrarian investor should reduce his over diversification and commit a large amount to few stocks where the odds weigh heavily in his favor.
By accepting market volatility: A contrarian needs to accept the volatility of equity markets. By maintaining plenty of cash through bull and bear markets, he can deploy funds during price drops.
By concentrating over absolute return than relative returns: A contrarian investor should not worry about index. An investor should plan how much cash he needs at the end of his investment time horizon and should try to perform in line with that strategy. By doing so, the investor will be more focused on his individual portfolio instead of worrying about the index performance.
A word of caution
Contrary thinking is emotionally demanding. It requires courage to stand alone when there is a great deal of pressure to follow the majority. The key to contrarian investing is making independent decisions and believing in them. And finally, it requires patience.