The stock market is riddled with thousands of different trading methods. Contrarian investment strategies are those that seek to go in the opposite direction of the market sentiment. These contrarians have empirical historical data to show that this works and the markets are always overreacting.
Contrarian investment strategies count on the fact that people are emotional beings. It takes into account investor psychology as a cornerstone in this method.
One simple contrarian investment strategy that has been touted is looking at P/E ratios. This stands for price per earnings and looks at the ratio of how much a company earns in relation to it’s stock price.
If a P/E ratio is low,that means the share price is trading very close to how much that share is earning. The contrarian investor sees this as low market sentiment.
The contrarian investor would look at companies with low P/E ratios and target them as potentially good stocks to invest in. They have data to show that low market sentiment leads to higher rallies and vice versa.
The the P/E ratio of a stock is high, there is optimistic talk in the business news media and high volume, the contrarian would look at this as a potentially good stock to short. This means that the market is overreacting to good news on the company and that reality will soon set in and the stock will go back closer to true value.
Again, the contrarian investment strategy relies on the fact that investors and the market in general are irrational. It also goes against the efficient market hypothesis that assumes that the market is rational and always values a stock properly taking into account all of the available information. The contrarian is more realistic than this.
This is one strategy out of the many that have empirical evidence that it works. But most people won’t do it because it goes counter intuitive to our natural sensibilities. This makes it hard for many people to do this.
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