1.
Use of the MindMap will foster an attitude of Contrarian Thinking: there is no necessity to take
2.
If you want to play contrarian you could make a lot of money
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“I'm not!” she defended herself with the contrarian anthem of the age
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My contrarian impulses were heightened by the fact that I’d just watched a bunch of scientists here at Emory University fawn all over the Dalai Lama
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How can the contrarian trader recognize an information cascade in the making? What clues should he look for to detect an emerging investment crowd and the investment opportunities it creates? In the next chapter we start to answer these questions by building a detailed description of the life cycle of a typical investment crowd
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Every contrarian trader must learn how to identify the point at which an investment theme has exhausted itself
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This return to fair value is the investment opportunity that a contrarian trader seeks to anticipate and exploit
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For this reason the contrarian trader must be always vigilant, always on the lookout for mature investment themes and investment crowds
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But this is not a problem for the contrarian trader
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Locating price relative to fair value is only the first step in the process of spotting a potential contrarian trade
11.
It is the combination of a potential valuation mistake together with solid, affirmative evidence that this mistake is caused by a mature market crowd that is the key to a profitable contrarian trade
12.
Sadly, this wonderful theoretical concept is not very useful as a yardstick for the contrarian trader
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But nowadays computers and the Internet have made the price data aspect of contrarian trading so much easier
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The Internet has become a tremendously useful data repository for the contrarian trader
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The goal of every contrarian trader is to beat the market—to earn an investment return that exceeds the return earned by the buy-and-hold strategy
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) There is only one kind of mistake a contrarian trader can make that will prevent him from matching or exceeding the buy-and-hold return: being out of or even short the market when it rising
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I am convinced that the difficulty of identifying periods of market overvaluation means that the contrarian trader, especially the novice, should focus his efforts on identifying and exploiting periods of market undervaluation
18.
I’ll have more to say about this matter in Chapter 11, in which I discuss “The Grand Strategy of Contrarian Trading
19.
I take it as axiomatic that the contrarian trader wants to avoid being caught in the stock market debacles of the sort that followed the bubbles of the 1920s and the 1990s
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This sort of extreme overvaluation does not occur very frequently, perhaps once or at most twice in the lifetime of a contrarian trader
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Being able to sidestep declines of this magnitude should be a goal of every contrarian trader
22.
I have just illustrated how a contrarian trader can identify situations of extreme overvaluation in the stock market
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But first a warning: I think only an expert, experienced contrarian trader should attempt to identify these less extreme periods of overvaluation
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I don’t think the effort is worthwhile for a newcomer to contrarian trading
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Obviously, the contrarian trader has to look for less extreme examples of undervaluation
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The most common bear market—and the one I think contrarian traders should become skilled in exploiting—is the short bear market that lasts about eight or nine months and drops prices about 20 to 25 percent
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I’ll have a lot more to say about how these short bull markets can be exploited when I describe “The Grand Strategy of Contrarian Trading” in Chapter 11
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This is indeed a fortunate situation for the contrarian trader
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Here, too, the basic rule that the media are profit-seeking entities that have to cater to people’s interests and prejudices serves the contrarian trader well
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Another illustration of how TV shows can give useful information to the contrarian trader occurred in July 2002, just as the S&P 500 index was approaching its bear market low at 768 (its low that month was 771)
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The forms and technology used by media will evolve, so a contrarian trader must be constantly involved in a media watch and be flexible and willing to adjust his procedures as needed
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It is the contrarian trader’s job to keep abreast of this evolutionary process, of the constantly changing nature of modes of mass communication
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It will be the content of these media that enables the contrarian trader to identify ideas and themes that drive information cascades
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While the mass media play an essential role in helping the contrarian trader identify information cascades and the investment crowds they create, these media are not the only grist the trader can or should use in his trading mill
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A contrarian trader must have extensive knowledge of the historical behavior of financial markets
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It is the job of the contrarian trader to stay abreast of informational resources so that when he needs historical information he knows where to look
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It is the job of a contrarian trader to know where he can obtain relevant information even as the world changes around him
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There is another source of information that can help the contrarian trader place current information cascades and investment crowds in their proper historical context
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To today’s novice contrarian trader these events no doubt seem to be ancient history, too
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But my personal experience as a market participant during the past 43 years informs everything I do as a contrarian trader
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It is essential for every contrarian trader to build his technique upon a body of experience, even if at the beginning of his career it is only secondhand
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A contrarian trader’s edge arises from two unusual skills
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It is his ability to translate observation and knowledge into profitable investment actions that distinguishes the contrarian trader from the run-of-the-mill devil’s advocate or naysayer
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How will your media diary do all this? How will it enable you to acquire the emotional balance needed for the high-wire performance of contrarian trading? The answer is surprising simple: Your media diary will objectify the emotional content of media messages and market movements by freezing them in time
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Only by learning how the media make you feel when a contrarian investment opportunity is at hand can you learn to act contrary to the media messages that urge the crowd onward to its doom and disintegration
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These deductions in turn will help you implement “The Grand Strategy of Contrarian Trading” (see Chapter 11)
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This is just about the hardest judgment any contrarian trader has to make
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This is one reason that statistical, survey-based approaches to contrarian trading tend to have little value
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” I have another folder containing stories of contrarian interest that aren’t cover stories and are too long to put in my spiral notebook media diary
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I have found Hulbert’s columns very informative at times because he himself is a devotee of the contrarian art
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Nonetheless, Hulbert’s contrarian warning was a very valuable piece of information for a contrarian trader, and the subsequent market rally was normal for the kind of evidence that Hulbert offered in his column
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As I have said, I like to keep a record of Hulbert’s views because he tries to take a contrarian view of the markets and often offers useful facts to back them up
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I first learned the value of using magazine covers in contrarian trading from Paul Macrae Montgomery
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Your job as a contrarian trader is to assess the current strength of the crowd and to use available historical precedents to make an educated guess about where the crowd is in its life cycle
55.
But the contrarian trader should be careful about being too skeptical about such themes when he first sees them emerge
56.
Of course no tree grows to the sky, but as we will see in subsequent chapters, the contrarian trader is often wise to join the bullish crowds of these individual companies and industries temporarily
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Once late-coming competitors arrive on the scene, it is usually time for the contrarian trader to leave the bullish crowd and consider taking a different investment position opposite the crowd’s theme
58.
These adjustments will see the birth and disintegration of many investment crowds in related markets and should provide a wealth of opportunities for the contrarian trader
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This means that the contrarian trader can often identify investment crowds in the bond market, especially after a long move in interest rates upward or downward has occurred
60.
One contrarian indicator of the stock market boom that properly began in 1982 was the popularity then of money market funds, which were regarded as fail-safe vehicles for assuring a prosperous retirement
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The amazing thing is that the contrarian trader can do this simply by monitoring the content of the mass media
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Why might it be useful to learn the semiotic art of reading between the lines? Our goal as contrarian traders is to identify market crowds that are near the point of disintegration
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The market’s price chart and the associated historical price tabulations are the starting point of any contrarian analysis you do
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Newcomers to the art of contrarian trading are often confused by the fact that in any market at any point in time there are always some bullish and some bearish voices to be heard, each with its own plausible arguments and rationales
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The art of contrarian trading requires that you learn how to identify the side of the market that is operating as a crowd, unified in its market rationales and emotions
66.
How wrong they were! And a look at the chart of the Dow would have shown that this contrarian interpretation of the Barron’s cover story was wrong-headed
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So the experienced contrarian trader had no reason to draw bearish inferences from the Barron’s cover
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So no bearish crowd could yet have formed, and thus there was no reason for the contrarian traders to draw (long-run) bullish inferences from this cover
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So the contrarian trader would not have taken this headline as evidence of a mature bear market crowd at work in the stock market
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So the contrarian trader might anticipate a relatively short-term bullish trading opportunity here
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Headlines convey very significant information about market crowds to the contrarian trader
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How much media and semiotic evidence must there be before the contrarian trader can be confident that he has identified a market crowd on the verge of disintegration? Is there some mathematical formula or guideline that can be applied to this process to make it more objective, to enable one to weigh the media evidence in some objective manner?
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So a contrarian trader must be careful not to expect a blizzard of cover stories and/or newspaper headlines to announce the imminent demise of an investment crowd
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This is one important reason why contrarian trading is at least as much art as it is science
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As the contrarian trader gains experience, his creativity begins to inform his work
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It can provide the contrarian trader with useful clues about the existence of market crowds
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The Grand Strategy of Contrarian Trading
78.
Becoming a contrarian trader • learn by doing • start small • a word to young readers • put yourself in the line of fire • my experience as a postcard trader • investment vehicles for contrarian trading • the advent of the exchange-traded fund (ETF) • investment goals • no need to be perfect • an example from the boom and bust 1990-2002 • tax issues • CTS #1: don’t speculate • why this is really a contrarian strategy • CTS #2: avoid big mistakes • inoculate yourself against crowd contagion • CTS #3: Contrarian Rebalancing • underweight when a bullish crowd develops • overweight when a bearish crowd develops • an example • best strategy to follow for the typical aspiring contrarian trader • suggestions for more aggressive contrarian trading strategies • an aggressive stock market strategy • look at bonds, commodities, stock market sectors, and individual stocks • it’s harder to track the crowd in such situations • the bandwagon strategy • the danger of trying the short side of a market • the odds favor the stock market bulls in the long run
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Every contrarian trader begins as a novice
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Making decisions when there is real money at stake is the essence of the experience and the only way to find out whether your emotional makeup is suitable to the contrarian approach to markets
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When I was starting out as a contrarian trader in college, I mailed a postcard every few weeks to a very experienced and successful money manager who happened to be a family friend
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You will also learn a lot about your suitability for contrarian trading
83.
Later, when you have saved enough to begin an investment program, your skills and experience as a contrarian trader will have been developed to the point where they will make a visible, positive contribution to your investment results
84.
What kind of assets are suitable vehicles for a contrarian trader’s investment plan? The key thing to remember is that his principal tool is his media diary
85.
It follows that the contrarian trader should focus on markets that receive the frequent attention of the print and electronic media
86.
This means that a typical contrarian trader will focus principally on stock market and bond market investments
87.
In my opinion, these currency and commodity market opportunities are generally best left to the very experienced contrarian trader
88.
Not only can they be dangerous, but contrarian trading opportunities in these markets arise only sporadically
89.
The typical contrarian trader’s attention is best focused on stocks and bonds, the biggest markets in the United States
90.
Financial innovations over the past 20 years have been a boon to the contrarian trader
91.
Up until the 1970s the only way to take advantage of contrarian trading opportunities in the stock or bond market averages was to buy a portfolio of individual stock or bonds
92.
In recent years this financial landscape has been completely transformed, to the delight of the contrarian trader and of the average investor as well
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THE INVESTMENT GOAL OF THE CONTRARIAN TRADER
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The contrarian trader’s goal is to beat the market
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Let’s imagine a hypothetical contrarian trader whose noncash investments are all in an S&P 500 index fund
96.
Imagine that, for whatever reason, this contrarian trader concluded in 1997 that there was a mature bullish stock market crowd that was about to disintegrate
97.
I should say that a contrarian trader who followed the Contrarian Rebalancing strategy described later in the chapter would not have sold until early 2001, and then near the S&P 1,250 level
98.
At what level in the S&P might this trader have restored his original long position? I think there was a very good contrarian buy opportunity in the S&P 1,000 to 1,050 range in October 1998
99.
(Again, an experienced contrarian trader would have seized the 1998 buying opportunity with both hands
100.
The active contrarian strategies described in this chapter will subject the investor to capital gains taxes when employed in a taxable investment account