Investing is a tricky business, and every strategy can reward investors in the long term. But in the short term, markets follow cycles where they peak out and tend to correct, or certain events cause markets to crash, like what happened during the aftermath of demonetisation or when the pandemic struck the nation. While most people follow the crowd and take out their money from markets due to panic during such times, a different breed of investors follow a contrarian approach towards investing during such times and make the most out of such corrections.
In this blog, we will discuss how contrarian investing strategies work and how they can help you generate better returns in the long run.
What is Contrarian Investing?
Contrarian investing is a strategy that involves going against the prevailing sentiment in the market. Rather than following the crowd, contrarian investors look for opportunities where the market is undervalued or overvalued. This approach can be challenging because it requires going against the prevailing wisdom, but it can also be profitable if done correctly.
One of the main advantages of contrarian investing is that it allows investors to buy stocks at a discount. When the market is undervalued, contrarian investors can buy stocks that are trading below their intrinsic value. This can lead to significant gains over time as the market eventually corrects itself.
On the other hand, when the market is overvalued, contrarian investors can take a more defensive approach. They can sell their stocks or short the market, betting that prices will fall in the future. While this approach can be riskier, it can also be very profitable if the market does indeed fall.
What are the different contrarian investing strategies?
There are several different strategies that contrarian investors can use to benefit from market cycles and events. Here are some strategies which can be used to benefit from them
1. In this strategy investors look for stocks that have been beaten down by the market but have strong fundamentals. These stocks may be undervalued due to temporary market conditions or negative news, but they may have the potential to rebound in the future.
For example: When the pandemic struck India and the country was going through lockdown the equity markets started falling and many stocks with good fundamentals were available at cheap valuations. It was a counterintuitive decision to invest in markets back then but if an investor would have followed a contrarian approach then very good returns could be generated as eventually markets went up again.
2. In this strategy investors look for stocks that are trading at a premium but have weak fundamentals. These stocks may be overvalued due to hype or speculation, but they may not be able to sustain their current valuations in the long run. Such companies are generally targeted for short side trades or holdings are exited by investors at or near peak valuations before the stock corrects.
An example of this is the fall of Adani group of companies when recently Hindenburg Research a US based short seller gave a negative report regarding the stock and pointed out the unreasonable valuation of the stocks owned by Adani Group. After this sell call by Hindenburg Research many of the listed companies owned by Adani group corrected significantly.
3. In yet another strategy contrarian investors may also look for opportunities in sectors or industries that are out of favour with the market. For example, if the market is bullish on technology stocks, contrarian investors may look for opportunities in other sectors such as healthcare or energy which are trading near bottom.
What are the disadvantages of Contrarian Investing?
Contrarian strategies can be very profitable but they come with their own risks. Going against the prevailing sentiment in the market can be challenging, and it can take time for contrarian investments to pay off.
In some cases contrarian investors also fall into the value trap or sunk cost fallacy and don’t take into consideration the fact that some stocks are cheap for a reason and may not recover even in future. They keep adding more shares at losses keeping faith in their investment thesis which may be turn out to be wrong. Hence it is recommended to always keep a stoploss and follow it strictly while following contrarian strategies.
In conclusion, contrarian investing is a strategy that can be very profitable for investors who are willing to go against the crowd. By looking for opportunities where the market is undervalued or overvalued, contrarian investors can buy stocks at a discount or take a defensive approach when the market is overvalued. While there are risks involved with contrarian investing, it can be a rewarding approach for investors who are willing to do their research and take a long-term view of the market.
Check out how our contrarian WealthBaskets have performed in the past here
1. Contra Stories by Elever Investment Advisors