Updated AD 2001 Feb 28.

/ Contrarian Investment Theory \

The thesis that an investment opinion contrary to the predominant opinion is, other things equal a better predictor of market results than the more popular opinion.

Disclaimer: If you use what is written in any node here as the basis for investing you're a lunatic!

Now Contrarians do not invariably go against the market consensus because the overall direction of the market is almost invariably correct, instead they are trying to find the extremes. That point when investors over correct or become irrationally exuberant.

As always the devil is in the details and so the difficulty is judging what is over or under valued. It might seem simple looking at a history graph with the extreme points, but it is not as clear when looking at present conditions.

Make no mistake, a contrarian strategy can hold large rewards, but it requires a good deal of risk as well. The management of risk is always at the heart of investing. The proposition of any investment is to risk your money (hopefully in a logical manner so it is more than just gambling) in exchange for gains. It is true that there are (a very few) investments are nearly risk free, like US Savings Bonds, but they don't have very high rates of return. To get a high rate of return means a bigger risk and trying to avoid this results in wreaks like that of Long Term Capital Management.

Another problem with some contrarians is their emphasis upon commodities as investments. Lots of money can be made in trading commodities, but holding onto them can make none. Profit is only realized when the pork, gold, wheat, or whatever is sold. If the stuff is bought and then the market does not recover as fast as the contrarian thought he could be stuck with little to no profit.

It is easy to be an armchair general and second guess a historical decision. But when dealing with the here and now it is not as obvious what the right decision is. It would be very easy to guess wrongly and end up getting out at the wrong time. Like two years ago when many arm chair contrarians said it was time to get out because the market was over valued.

But it is also true that the market does get out of whack. People panic or have to sell to cover other investments going bad and so on. So it is not true there is no merit to the contrarian strategy. It just must be made as part of a calm and rational approach to financial investment.