Contrarian Investing Made Easy (1 tool to use)

“The time to buy is when there is blood in the streets.” This quote, credited to Nathan Mayer Rothschild, is used to refer to a contrarian investing strategy.

If everyone is freaking out, it can be extremely profitable to go against the grain and buy company stocks at what could be incredible discounts. With fears of a recession on the horizon, this quote, and the underlying idea of ​​being a contrarian investor, is more relevant than ever. But before I get too far into contrarian investing, I want to share a brief overview of the Rothschild dynasty so you can understand the life-changing wealth that can be created by going against this. that everyone does.

A dynasty worth $500 billion

Since 1811, the Rothschilds have been successful in London banking (today the family is worth an estimated $500 billion), making their fortunes in government bonds and bullion. But Nathan Rothschild also pioneered alternative methods of income generation, discovering an opportunity to profit from the Napoleonic Wars.

Supporting the Duke of Wellington, he lent money to English troops in their efforts against Napoleon. The Rothschilds naturally made money as debts were paid off, but they also speculated extensively in the stock market.

While Napoleon fatally confronts the English armies at Waterloo, Nathan plays his advantage. It was a time before the Internet, the telephone or even the telegraph. Thanks to Nathan’s network of suppliers and agents across Europe, he was able to get advance warning that Napoleon had been defeated.

Realizing that he was in possession of information that no one else had, Nathan sold heavily on the market. And as other investors took notice, they followed suit, driving the market lower. Nathan then returned to the market and quietly bought back almost the entire stock market at deeply discounted prices. Then, as the news made its way across Europe, investors returned and the market soared, generating even greater fortune for the Rothschilds.

Aside from the accuracy of the exact details of this story… Nathan Rothschild’s strategy has been summed up by the saying “buy with the sound of guns, sell with the sound of trumpets”, and it fully embodies the spirit of investing at countercurrent.

Against a current

At its core, contrarian investing is a financial philosophy in which enthusiasts oppose prevailing market trends, selling when others are buying and buying when many investors are selling. If an opponent thinks everyone is buying and the stock is overvalued, they can look for short selling opportunities or stay on the sidelines with a pile of cash.

When stocks go back down and look oversold, the offender uses the pile of cash they were sitting on and buys stocks at a lower price than they were trading at before. The philosophy is simple enough, but one of the biggest challenges of following a contrarian investing strategy is the enormous research involved in evaluating a stock’s fundamentals and accurately measuring investor sentiment.

There are a number of tools you could use to help you with your decision-making process, but I’ll focus on just one for now.

The Fear and Greed Index

For investors looking for clues about possible entry and exit points, the Fear & Greed Index helps identify extremes that signal highs and lows. It does this by assessing market sentiment or bullish or bearish investor sentiment at a given time.

The Fear & Greed Index distills the prevailing sentiment into one of five designations:

  • Extreme fear
  • Fear
  • Neutral
  • Greed
  • Extreme Greed

the CommerceSmith The Fear and Greed Index can be accessed from the dashboard of our Trade360 program.

To get a sense of where the market is headed, the index uses seven benchmark measures.

  • Request for junk bonds – Measures the popularity of lower quality high yield bonds. When investors are greedy, they tend to seek higher returns regardless of the risk. However, when the tide turns, their fear pushes them towards safer investments.
  • Market dynamics – Reveals how far the S&P 500 is moving above or below its 125-day moving average. Fearful investors are starting to sell, sending the S&P 500 into a downtrend, which could push it below its 125-day moving average. The exact opposite happens when investors are greedy.
  • Market volatility – Tracks the latest price of the Chicago Board Options Exchange (CBOE) Volatility Index, or VIX. This index measures expected price movements, or volatility, over the next 30 days and is a very useful indicator of market fear and sentiment. High readings in the VIX are usually associated with high levels of fear in the market.
  • Shelter request – Compares the recent performance of equities to that of US Treasuries. Fearful investors, feeling bearish, often gravitate toward the relative safety of bonds. Selling stocks to buy bonds causes bonds to outperform. However, greedy investors, feeling bullish, accept greater risks on stocks with higher potential gains.
  • Stock price range – Measures the difference between the rise and fall in volume of stocks listed on the NYSE. A higher volume of falling stocks is an indication of more fearful investors. If it hits an extreme, it may signal a bottom. However, an extreme in higher volumes of rising stocks may indicate a peak in the market.
  • Stock price strength – Compares the difference between the number of stocks reaching one-year price highs and the number of stocks reaching new one-year price lows. Fearful investors tend to generate more one-year lows. The extremes of this measure can signal a bottom in the market.
  • Put and call options – Compares the trading volume of bearish put options and bullish call options. More put options are bought by fearful investors, which increases this ratio; greedy investors buying a majority of call options drive this ratio down.

How contrarian investors use these measures to their advantage

Each of these measurements brings the needle closer to the Extreme Fear or Extreme Greed end.

The contrarian makes investment decisions based on the opposite of the herd mentality. Therefore, if the Fear & Greed Index indicates extreme fear, it is the same as investors calling for a downturn, and the naysayers know to rush in and grab the discounted stock. It’s time to buy.

If the needle is pointing to Extreme Greed, it is likely that the market is overbought and the countercurrent is starting to unload. It’s time to sell. This natural ebb and flow between fear and greed is part of the life cycle of stocks. And our fear and greed index can help you ride the waves of investor sentiment toward better returns.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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