You have probably heard the term ‘contrary investor’ or ‘contrarian’ before. If not, why not look it up on Investopedia? At its heart, the concept of benefiting by going against the crowd is both incredibly stupid and incredibly smart.
Going against the crowd would be stupid when you do it right in the middle of the crowd’s actions. A good example of stupidly going against the crowd would have been going short technology stocks in 1999, just a year before the internet bubble burst. You could have easily lost everything.
So if you want to profit from speculating (benefiting from future stock price moves that you predict), it would be foolish to go against the crowd. But what about value investors? Does being a contrarian hurt or help us?
When everyone is selling, there is usually panic and fear. When there is panic and fear, there is very little reasoned thought. When people are not being reasonable, prices in the stock market will tend to go far away from fair values. In this case, this usually means there is a good chance for a stock to be bought really cheap. It is our job to buy from panicked sellers, and thus make easy money later on when we can sell those same stocks at fair values.
The opposite situation, selling when everyone else appears bullish, applies to speculators but not to us. A smart speculator could have foreseen the bursting of the Internet stock bubble that burst in 2000. Early in that year, there was IPO mania, executives were exuberant, and people talked of naught but their tech stocks. That would indicate that everyone who was going to buy stocks already had. There was no one left to buy, and the stocks had no where to go but down. The smart speculator would then have sold, reaping enormous profits. If he were adventurous, he could have even sold tech stocks short, making even more money.
We would not have acted in the same manner, though. None of those tech stocks were good values in 1999. Value investors may have bought into some of them earlier on, but a value investor will always sell out when prices become way overvalued, before they become obscene.
So when investing, look for areas where others are fearful. If you find those fears to be unfounded, you might find yourself a good investment.