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Monday, July 19, 2010

The Contrarian Investor

Most investors look favourably upon stocks rising in price and reject those falling.

This conventional model causes them to overlook quality companies with prices that have fallen because of events or perceptions that are transitory in nature.

The stock market is the only marketplace where the merchandise gets more popular as it gets more expensive. That is because the "herd" mentality on the stock market says that, if a stock is rising, it must be worth buying.

Invariably, however, those in the "herd" end up getting trampled when the stock's promise is not realized. Those who have the courage to act on convictions that may run counter to the market's "group think" can find the rewards substantial.

The Contrarian Philosophy is to act contrary to the conventional wisdom in stock investing at any particular time.

When others Are Selling: Contrarians BUY!

When others Are Buying: Contrarians SELL!

The contrarian philosophy may appear to contradict other investment strategies, but actually it uses other investment decision methods in an inverse or stubborn way.

The contrarian philosophy is to act contrary to the conventional wisdom at any particular time.

Contrarians believe that tens of thousands of investors pursuing the same course at the same time is like a cattle stampede.

Contrarians say do not risk your money by following the crowd, because it sometimes acts without reason. When the invalidity of its mob behavior becomes apparent, the whole crowd will reverse and swing the other way - again for irrational reasons.

One contrarian strategy is to purchase stocks that are out of favour, or stocks in industries that are out of favour, with the market. Following some disappointing news, a sudden drop in price of a stock, or in stocks across an industry, may be caused mostly by a periodical overreaction.

The over reaction may push prices down to bargain levels. Contrarians think that this is a good time to buy, because, a stock falling in price becomes more attractive. By purchasing the stock of companies that are out of favour, the contrarian has an opportunity to realize profit when these companies regain popularity. Typically, this process involves less initial risk, since purchase prices usually are at the low end of their valuation cycles.

When investing for the long term, market changes are unavoidable. Logically, as the market evolves, the contrarian model will rotate in and out of favour.

Since only one approach cannot advance you toward your financial goals. The contrarian model should be included as a component of a carefully designed and diversified portfolio.