Stock Market Rally, Time to be a Contrarian?

By: Claus_Vogt

Claus Vogt writes: Many successful investors and speculators, like Warren Buffett and George Soros, are said to be contrarians. But what does this really mean? And is it true?

Let’s have a look at the concept of contrarianism to find out whether it can give us some guidance during these exciting times …

Contrarians are investors with deep knowledge and strong self-efficacy. They possess a rare nature: They’re willing and capable of forming an independent opinion and sticking to it. Even if a huge majority of analysts, journalists, colleagues, and friends hold an opposite point of view.

As the legendary Wall Street analyst Henry Kaufman wrote in his memoirs:

” … most predictions fall within a rather narrow range that does not deviate from consensus views in the financial community. In large measure, this reflects an all-too-human propensity to minimize risk and avoid isolation. There is, after all, comfort in running with the crowd. Doing so makes it impossible to be singled out for being wrong, and allows one to avoid envy or resentment that often inflicts those who are right more often than not.”

Warren Buffett doesn’t mind bucking the trend when he gets the right signals.

But contrarians usually don’t take the easy route … they’re accustomed to swimming against the stream. And they rarely make friends by doing so. Instead they expose themselves to mockery when they’re wrong and to wrath and envy when they are right.

In Fact, There’s a Risk with Always Being a Contrarian …

Contrarians may be early with their timing. For that, they will be laughed at. But they don’t mind … they know that they’ll eventually be proven right.

They know that imbalances and the madness of crowds can go on much longer than anyone can imagine ― so they wait for the unavoidable to happen. Hence contrarians need patience and discipline. They have to have the guts to try again and again to finally catch a major trend change.

Only by luck, though, will they hit a homerun with the first try. More often than not they have to implement a position step by step to average down their costs. Or they’ll try to get in a few times, only to be stopped out with a small loss again and again until finally they get it right — and hit it big!

My Point Is Simple: It’s Good to Always Think Like a Contrarian, But You Should Only ACT Like a Contrarian When the Time Is Right …

Markets are trending, and strong trends can regularly go on for many months or even years. As long as a trend is intact, investors should embrace it and run with it. Only during its end, when it’s on the verge of turning, should you jump off and become a contrarian. Otherwise you’ll always find yourself fighting the trend instead of making some nice gains.

So it should be clear then that a successful investor must approach the market with the skepticism of a contrarian but also know how to follow the trends.

How can this be accomplished?

By applying technical analysis and common sense.

There’s no holy grail of investing. But there are some very good and rather simple tools, or indicators, that can help you know when it’s time to follow or buck the trend.

One of the best known trend-following tools is the 200-day moving average. As long as it’s rising, you should be looking to buy the dips. And when it’s declining, you should be looking to sell the rallies.

Combine it with the advance/decline line and the advance/decline volume line to give you early warnings of a possible trend change.

Smart investors know when it’s time to leave the crowd … and become contrarians.

Of course that’s not all it takes to become a good investor. Monetary policy and macro-economic analysis should be added to your analytical tool box, too.

And here’s a piece of old Wall Street wisdom that’s regularly forgotten exactly when it’s needed the most: “Never fight the Fed.” So contrarians watch for short-term rates to go higher than long-term rates. That tells them that a recession and a stock market plunge could be coming.

Finally, you should follow the leading economic indicators (LEI). In my August 26 Money and Markets column, I told you how the LEI is the most successful recession predictor I know of. When they signal a recession, you should believe them and start to leave the bullish crowd. And when they’re predicting that the economy will grow, you should value this insight and act accordingly.

Today the LEIs are predicting that the economy will grow. Fed policy is very lax. And the S&P 500 index’s 200-day moving average is rising as are the advance/decline lines.

Therefore, you should expect the stock market’s rise to continue no matter what the little contrarian inside you might be thinking.

Best wishes,

Claus

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