Contrarian Traders

As the name suggests, contrarian traders tend to go against prevailing market trends. They look to buy assets when they are performing poorly, then turn around and sell them when their performance improves. (See What is Contrarian Investing?)

Contrarian traders tend to believe that those who classify the market as going up tend to do so only when they are fully invested, meaning they have no further purchasing power. Similarly, people who predict a market downturn tend to have already sold out, suggesting that the market can only go up.

These traders make use of a number of investor sentiment indicators, especially those which emphasize out-of-favor securities (those with low P/E ratios).

Basics of the strategy

Contrarian investors don’t just always go against the public or the larger investor pool. Just because a stock trends higher and higher does not mean that a contrarian will automatically hate that stock. Rather, these investors look for stocks for which public sentiment runs counter to the established trend; the ideal contrarian investor stock would be one that is going higher in price, even as there is a growing amount of pessimism among the general investor base.

Indicators for a contrarian investor

Contrarian traders monitor markets and market news in order to assess broader sentiment. (For more on indicators that contrarians monitor, check out Why is the disparity index indicator important to contrarian investors?)

Traders making use of a contrarian strategy rely on analyst ratings as a gauge of where investors are landing relative to a particular stock. If a stock is moving upward in price, but there are few “buy” recommendations, a contrarian might see potential. Contrarian traders also make use of shorts and options in order to profit off of declines in price.

Contrarians tend to use sentiment surveys, put-call ratios, volatility index (VIX), and more. They also operate on their own reactions to analyzing data.

Benefits and risks of contrarian trading

Contrarian traders have the potential to be highly successful, provided that they remember that opinion and action are very different. They also must keep in mind that trends are where the money is, and that price confirmation is necessary for any reversal.

Some of the most famous contrarian investors have wagered large amounts of money on their successful bets, but it’s not so simple as that. Successful contrarians must be very well-researched, and they must also have a high degree of confidence in what they are doing.