Contrarian Investing (Part 1) – Examining the Process

Thursday, December 10, 2009

987763_man_thinkingContrarian investing is so important that I want to discuss it further. The concept is challenging, and most investors do not apply it well, if at all. The potential rewards are considerable. Practicing contrarian investing can be financially beneficial and help prevent mental anguish.

Here are the next three day’s topics:

  1. Today, the characteristics of contrarian investing
  2. Tomorrow, examples of investment managers I have worked with who successfully practiced contrarian investing
  3. Monday, examples from my own fund management experiences

Question everything

Contrarian investing success requires questioning everything and being open to alternative explanations and actions. Why? Because investing is highly susceptible to mass psychology. Beliefs and actions can become popular or unpopular beyond reason. However, there is little money to be made from investing with the crowd. Only when we act in front of others do we have the potential to earn large gains. Doing so often requires thinking and acting differently – hence, contrarian.

Contrarian investing has three parts

First is the search for information being ignored or incorrectly analyzed. Finding such items allows us to get into or out of a position ahead of others.

Second is spotting emotional overreactions. A characteristic we all share is emotions. No one is immune – not even the best investment managers. Unfettered, emotional investing produces outsized losses and missed opportunities. Contrarian investing can convert these times into real returns.

Third is a willingness to act, seemingly alone. This is where experience really helps. After actions are taken, unless timing is perfect, there can be a waiting period that tests patience and perseverance. Personally, I like to remember Robert Frost’s poem, “The Road Not Taken” (Mountain Interval, 1920). The final stanza is:

I shall be telling this with a sigh

Somewhere ages and ages hence:

Two roads diverged in a wood, and I—

I took the one less traveled by,

And that has made all the difference.

So, contrarian investing is an important part of an investment program. Correctly executed, it can add return and reduce risk.

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