Contrarian Investment Strategy: It pays to be different!

Behavioural Finance tells us that markets swing between the extreme emotions of greed and fear. Market movements generally reflect the irrational behaviour exhibited by a group of investors working towards acheiving a common objective. Various theories/strategies have been propounded by experts on stock market investing. One such strategy is the 'Contrarian Investment Strategy'.

A contrarian strategy is one that relies on making profits by investing in a manner that differs from the conventional wisdom, hoping that the the consensus opinion will prove to be wrong. A contrarian believes that crowd behavior among investors can lead to exploitable price differentials (underpricing or overpricing) in securities markets. Practicing the contrarian investment strategy can lead to above average gains from the markets. A contrarian seeks opportunities to buy or sell specific stocks when the majority of investors appear to be doing the opposite. This approach has the tendency to misfire in the short term, as you are trying to swim against the tide. Patience is the key to succeed as a contrarian investor. Commonly used contrarian indicators for investor sentiment are Volatility Indexes (informally also referred to as "Fear indexes") like VIX, which track the prices of financial options.

Contrarian investment strategy has similarities with value investing strategy as the contrarian is also looking for mispriced investments and buying those that appear to be undervalued by the market. Warren Buffet is one of the legendary investors of our times who has used cotrarian strategy to make windfall profits on the markets. Some Mutual Fund houses in india have also floated specific 'Contra funds' that follow the principle of contrarian investing. Let us take an example: last year in January '08, at the peak of the bull phase there were a few takers for automobile companies in India. Most of these companies from the forward group like Maruti, Hero Honda have proved to be the best performers one year after. Similarly, at the current juncture, telecom sector has been given a thumbs down by the markets, and most analysts are negative on the sector for the next couple of quarters. A blue chip stock like Bharti Airtel is quoting at an all time low PE multiple of 12. If somebody invests in this stock today, using the contrarian strategy, I am fairly optimistic that he/ she would be able to make decent gains in the next 1-2 years.