How to Be a Contrarian Investor

By Wendy Connick Markets Fool.com

The best known investment advice has to be: "buy low, sell high." In other words, buy stock when the market is at the bottom of a slump, and sell it when the market approaches a peak. The problem is, most people do just the opposite because they get sucked into the herd mentality. As the market climbs, people feel more and more optimistic about stocks. They see the value going up and think, "I've got to buy more stock now because everyone else is buying." Eventually, everyone who might buy stock will have done so, and the stock market will promptly take a tumble because now no one is buying anymore.

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Just the opposite happens when the market is going down. As investors see their stock losing value and everyone around them is selling off shares, eventually they'll throw up their hands and sell their stock as well. Eventually, everyone who is ready to sell will do so, and so the market will start to come up again as buyers once again outnumber sellers.

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Contrarian investing is the practice of bucking the herd. Contrarians buy stock when everyone else is panicking and selling theirs, because they know that a flood of stock sales means that the market is near, or at, its bottom and will soon begin to recover. They sell whenever investors become extremely optimistic, because when everyone is buying that usually means the market is at or near a peak and is about to take a dive.

Contrarians often look for polls and surveys that show either extreme optimism or extreme pessimism from average investors. Following the mantra "if everyone's doing it, it's wrong," contrarians will do just the opposite of what the surveys suggest: they will buy stock when everyone is screaming "sell" and sell when everyone is screaming "buy." For example, a contrarian investor might consult the most recent Gallup poll that asks investors whether or not they think investing in the stock market is a good idea right now, then do the opposite. Note that this approach draws on investor attitudes toward the market as a whole; there may be a very good reason to dump a particular stock, such as an impending bankruptcy.

Another common market timing signal for contrarians is breaking investment news: again, not to take the related action but to do the opposite. Even in the Internet age, by the time a piece of stock-related information has gone public, the market has already assimilated this information and adjusted stock prices to take it into account. By the time you read about the wonderful economic indicator that's sure to propel the market upwards, the market will already have taken off. Contrarians say that this makes such moments a great time to sell, since as soon as everyone else who read that news story has finished buying the market is likely to head back down again.

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Be aware that, like all market timing strategies, contrarian investing is far riskier than a buy-and-hold investing strategy. Buying a well-diversified portfolio of investments and hanging onto it through all market gyrations is still going to result in the highest returns over the long haul, which is why the Motley Fool recommends this approach and doesn't advocate market timing strategies. Note, you also don't have to time the market to be a contrarian investor. Sometimes it just means believing that a company that has been beaten-down has long-term potential. If you buy a company like this and hold on to it -- hopefully reaping future rewards -- you can be a long-term contrarian investor.

However, if you do decide to give timing the market a try, you could do worse than adopting a contrarian approach. After all, it was Warren Buffet who advised investors to "be fearful when other are greedy, and greedy when others are fearful." Now there's a saying contrarians can rally around.

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