‘Be Fearful When Others are Greedy & Be Greedy When Others are Fearful’ – Famous quote by an American investor, business magnate, and philanthropist i.e, Warren Buffett. Many of us have read or heard about the above line but few of us have understood it. It means when everyone is buying in the market, it is time to sell and when everyone is selling, it is time to buy. Such investors are known as contrarian investors and such strategy used by them is known as Contrarian Investing. Basically, a contrarian investor buys in a bear market and sells in a bull market. Sometimes, it is also referred to as ‘Buy on Dip’ and ‘Sell on Rise’.
Contrarian Investing Rules
Investors who identify themselves as contrarian investors believe that most investors are incorrect in their investment decisions. So contrarian investors take an investment decision that is the opposite of what the majority is doing. Following are some of the rules used by contrarian investors:
A lot represents 100 shares of common stock. Any trade of less than 100 shares is referred to as an “odd lot”. It is identifies as the trades of smaller individual investors. It is assumed that most individual investors are wrong in their investment decisions. So, if small investors are bullish, then contrarians would interpret them as a bearish signal and sell his/her positions. If small investors are bearish, the contrarian would interpret that as a bullish indicator and buy into position.
Cash Positions in Mutual Funds
Contrarians view small investors as represented by odd-lot trades. However, they see Mutual Funds as representative of institutional investing. They analyze the amount of cash, a mutual fund manager currently has, relative to the total value of the fund. If the fund manager is bullish on the market, the portfolio would be fully invested in the relevant markets, with less cash in the portfolio. For a contrarian, this is a bearish indicator and a signal to sell. On the other hand, if a mutual fund manager is bearish on the market, cash would be in a larger percentage of the fund. To the contrarian, this is a bullish indicator and the signal to buy.
200-day moving average
It calculates the average closing price for the 200 most recent trading days. At the next trading day’s closing price, the oldest day’s price drops off and the newest closing price is added to recalculate the average. Therefore, each new trading day this process continues and produces a rolling 200-day average. When 80% or more of the securities in the market are trading above their 200-day moving average, it is considered a bullish indicator for the overall market and a bearish indicator for the contrarian and vice versa.
It shows the number of securities that are currently trading higher than the previous day’s closing price (Advance) relative to the number trading below the previous day’s close (Decline). When the ratio of advance to decline increases, it is a bullish indicator for investors and bearish indicator for contrarians. Sometimes, it is also referred as the breadth of the market.
This ratio compared the total number of open “put” contracts in the market compared to the total number of open “call’ options. The higher put/call ratio indicates a bearish outlook, which is a bullish indicator for the contrarian and low put/call ratio would signal the opposite. It represents overall bullish outlook to investors and the bearish outlook for contrarians.
Similar to the put/call ratio, this trading rule looks at the total number of shares that have been sold short relative to the total number of outstanding shares. When the number of shares sold short is high, it is seen as a bearish sentiment of the company, which would be a bullish indicator for the contrarian.
From the year 2015, many events came into the stock market as an opportunity for long term investors. Following are some of the events happened in Indian stock market:
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Experienced and smart investors bought quality stocks and didn’t stop their SIP in the above-mentioned events. They got value stocks at a very cheap price and low NAV in mutual funds. It results in superior returns when the market bounces back.
Each contrarian investor has his/her own strategy for investment. Besides, they all have one common strategy. They wait for the right opportunity that the market brings to them rather than chasing the market. Below are two good strategies of contrarian investing we can use –
1] Averaging the quality shares in correction or bear market.
2] Short-blast SIP in mutual funds.