Contrarian Opinion - Worth Thinking About

hen entering the stock market it is too easy to get caught up in the technicalities of 'reading' the charts or analysing the company reports. Sometimes the market just doesn't make sense. For example, the gold price may drop and yet Gold producers’ shares may rise in value. It is worth taking a step back (again) and remind ourselves that the market is comprised of individuals herding together, and as everybody knows the behaviour of a herd is more basic than that of an individual. This behaviour can be frustrating for both the investor and trader but if analysed and understood for what it is you are able to take advantage - as many finance professionals do - of the opportunities it creates.

Herd Mentality

During the market cycle, the psychology of the herd moves from pessimism and fear to hope, overconfidence, and greed. The feeling of confidence is built up over a period of rising prices, so that optimism reaches its peak around the same point that the market is also reaching its high. Conversely, the majority is most pessimistic at market bottoms. Financial journalists and the media at large add to the hype, adding impetus to the optimistic and pessimistic cycles by promoting feel-good stories of success and wealth at the top of the cycle and outlining the disastrous consequences of investment at precisely the point when the acquisition of stocks should be taking place.

Many of the better-informed market participants, such as insiders and institutions, act in a contrary manner to the majority by selling at market tops and buying at market bottoms. Both the herd and the insiders go through a complete cycle of emotions, but in completely opposite phases. This is not to suggest that members of the public are always wrong at major market turns and that professionals are always correct, but that in aggregate the opinions of these groups are usually in direct conflict.

Proponents of contrary opinion are able to draw on many examples of stock market behaviour, such as the South Seas Bubble and the Wall Street Crash, to analyse and refine the theory. In the U.S. companies such as 'Market Vane' produce a Bullish Consensus that provides a Contrarians measurement. By collating opinions from market makers, brokers, investment houses and journalists they are able to track the percentage of Bulls and Bears in the market. Data is available on many of these market participants, so that over a period of years it has been possible to derive parameters that indicate when a particular group has moved to an extreme, which is historically associated with a major turning point.