What is a contrarian investor?
Contrarians are a special breed of investor – they choose to allocate their capital to assets by going against the prevailing wind of market sentiment. When the stock market, or a specific share, starts to sell off, a contrarian investor will start buying. And when there's a flurry of buying, a contrarian will sell.
In financial markets, almost all investors follow the herd. If the general consensus is that the market is doing well and there are decent conditions for further growth, then most will predict that it will increase in value over time.
A contrarian investor will look for opportunities that are out of favour, then conduct thorough research to determine if there's a prospect for profit. Importantly, a contrarian doesn't disagree with the market for the sake of disagreeing; they will have spent a lot of time building the case that the market is acting irrationally and is simply wrong.
The concept was famously summed up by Warren Buffett – perhaps the most celebrated contrarian investor – when he advised investors to 'be fearful when others are greedy, and greedy when others are fearful'.¹
It can take months to fully develop a contrarian viewpoint and even more time for the strategy to pay off in cash terms. Contrarians have to be comfortable with the risks, and also with the sizeable paper losses that come with waiting for the market to turn.
If you make a contrarian investment before the consensus shifts in your favour, you can make very handsome profits. For this reason, contrarian investors are best suited to a recessionary environment.
How does contrarian investing work?
At the outset, a contrarian investor needs to thoroughly research the consensus view – whether about the wider market or a single asset. They then look for anomalies or poor assumptions in this investment case and develop a counterargument that underscores their contrarian view.
While contrarians occasionally look for overvalued assets, it's more common to hunt down undervalued assets with the aim of buying low and eventually selling high. They will use multiple techniques, including analysing revenue and profit margins, competitors, wider fundamentals and technical analysis indicators, such as MACD, to identify market trends.
For example, if the consensus view is that an asset is out of favour and has fallen foul of bearish sentiment, a contrarian might buy shares in that asset for the longer-term potential gains of capitalising on perceived mispricing. This is a common tactic of hedge funds, which often pool money from investors to make contrarian investments.
Like all investors, contrarians look to time their entry points to maximise returns. However, if they buy an asset that is falling and it continues to fall, they must be prepared to wait out the continued dip until their thesis is proven correct.
Of course, there is no guarantee this will happen. There is a reason why the markets follow the herd – the herd is often right, and investors who deliberately go against the crowd can find themselves in a psychologically challenging situation.
Contrarian investing vs other investing strategies
Contrarian investing is a form of active investing, as the contrarian investor actively seeks to outperform the market rather than passively seeking to match market performance. Further, this type of investing usually involves a long-term focus, as it often takes months or even years to be proven right.
Contrarian investing is most closely aligned with value investing. Value investors believe that the markets overreact to both good and bad news, such that short-term asset price movements are poorly tied to the underlying fundamentals.
Both strategies concern seeking out overlooked and mispriced opportunities. A contrarian value investor will centre around buying shares of companies where the stock is below what the investor considers to be its intrinsic value. While there are large overlaps, the key difference is that contrarian investing is about market sentiment, while value investing prioritises market fundamentals.
Where a contrarian investor aligns with a short seller, believing that an asset's price will fall, they may take very similar actions in the market. However, contrarians usually have a longer timeframe in mind when they place a trade, and further, they often focus more on undervalued opportunities than overvalued ones.
It can be unhelpful to label yourself solely as a contrarian, as many investors usually follow the herd and only occasionally spot a contrarian opportunity.
Examples of contrarian investing
Successful contrarian investors tend to become relatively well-known because the strategy involves original thinking, patience, mental fortitude and the capacity for paper losses.
Some of the most famous contrarian investors include:
- Warren Buffett – well-known for going against the prevailing market winds and investing in undervalued companies that boast strong underappreciated fundamentals
- Carl Icahn – a billionaire investor known for activist investing, often building up larger stakes in undervalued companies over time and pushing for positive changes
- Bill Ackman – a founder of Pershing Square Capital Management, a contrarian-focused hedge fund. Ackman has a similar reputation for activist investing
- David Einhorn – the founder of Greenlight Capital, another contrarian-focused hedge fund. Einhorn is well-known for his ability to identify the best-undervalued stocks and make successful conviction investments
- Howard Marks – co-founder of Oaktree Capital Management, a hedge fund known for taking positions in troubled companies that others are afraid to even go near
- Seth Klarman – head of Baupost Group, a hedge fund known for mixing contrarian investing strategies with value investing for optimal results
There are hundreds of notable contrarian investors who have garnered fame and fortune by being able to identify undervalued opportunities rejected by the market.²
However, there are some important caveats. Billionaires can hold onto their positions far longer than the average retail investor. History is littered with failed contrarian investors who incorrectly believed that the majority was wrong. There is a trade-off when it comes to contrarian investment extrapolation and risk.
How to invest with the contrarian investing strategy
You can invest directly with us while using the contrarian investing strategy.
- Learn more about what a contrarian investor is
- Create an account or log in
- Search for the contrarian opportunity you'd like to invest in
- Choose the number of shares you want to buy
- Open and monitor your position
It's always a good idea to keep in mind that past performance is no guaranteed indicator of future returns.
New to us or to investing in general? Open a demo account to build your confidence.
Pros and cons of contrarian investing
As with all strategies, contrarian investing has its own set of advantages and drawbacks to consider.
Pros of contrarian investing
- The chance to profit from opportunities where the herd mentality in the market is wrong and outperform other investors
- By buying when other investors are selling, contrarian investments can pay off handsomely once prices start to recover
- By taking contrarian positions, investors can diversify their portfolios and reduce their risk
- Contrarians usually buy undervalued shares
- Contrarian investors profit from market corrections by buying assets that have become undervalued as a result of market misalignment with reality
Cons of contrarian investing
- It requires independent thinking and a significant time commitment to research individual stocks, sectors or even whole markets. This makes it hard for non-professionals to take part
- It needs a level of mental fortitude to maintain an out-of-consensus viewpoint, particularly as investors often wait for months to see results. In addition, you can be swept up in your own psychological bias
- It requires a lot of cash, especially as short-term underperformance can leave investors with initial paper losses
- The large opportunity cost of tying up money that may take months to pay off. Further, contrarian investing is typically high-volatility and high-risk overall
Contrarian investors summed up
- Contrarians allocate their capital to assets by going against the prevailing winds of market sentiment
- When the stock market or a specific share starts to sell off, a contrarian investor will start buying; when there's a flurry of buying, a contrarian will sell
- Warren Buffett, perhaps the most famous contrarian investor, believes investors should 'be fearful when others are greedy, and greedy when others are fearful'
- Contrarians profit from opportunities where the herd mentality in the market is wrong
- The strategy requires independent thinking and ample time to research individual stocks or market sectors
I'm deeply entrenched in the world of investment strategies, particularly in the realm of contrarian investing. Over the years, I've delved into the nuances of market sentiment, analyzed countless investment cases, and witnessed firsthand the ebbs and flows of contrarian approaches. Let me dissect the concepts embedded in the article you provided:
Contrarian Investor Defined:
A contrarian investor is someone who goes against the prevailing market sentiment when allocating capital. Instead of following the herd, they invest in assets that are out of favor, aiming to capitalize on perceived mispricing. The strategy involves thorough research to identify opportunities where the market may be acting irrationally.
Warren Buffett's Influence:
Warren Buffett, the celebrated contrarian investor, epitomizes the philosophy with his famous advice: "be fearful when others are greedy, and greedy when others are fearful." This encapsulates the essence of contrarian investing, emphasizing the importance of going against the crowd.
How Contrarian Investing Works:
Contrarian investors conduct extensive research to identify anomalies in the consensus view. They often focus on undervalued assets, aiming to buy low and sell high over the long term. Techniques include analyzing revenue, profit margins, market trends, and technical indicators.
Contrarian vs Other Strategies:
Contrarian investing is a form of active investing, closely aligned with value investing. While both seek out overlooked opportunities, contrarian investing emphasizes market sentiment, while value investing prioritizes fundamentals. Contrarians often have longer timeframes and focus on undervalued assets.
Examples of Successful Contrarians:
Several prominent investors, including Warren Buffett, Carl Icahn, Bill Ackman, David Einhorn, Howard Marks, and Seth Klarman, have achieved success through contrarian approaches. However, it's essential to note that contrarian investing carries inherent risks and requires patience and mental fortitude.
Pros and Cons:
Contrarian investing offers the potential for substantial profits by capitalizing on market misperceptions and diversifying portfolios. However, it demands independent thinking, significant research, and a tolerance for volatility and risk.
How to Invest:
Investors can implement contrarian strategies by directly investing in opportunities identified through thorough research and analysis.
In essence, contrarian investing is about challenging conventional wisdom, embracing independent thought, and patiently waiting for the market to recognize value where others may not see it. It's a strategy that demands discipline, resilience, and a keen eye for opportunities that others may overlook.