So You Think You're a Contrarian?

• Posted by Derek
• on July 16th, 2010

“I knew Jack Kennedy.  Jack Kennedy was a friend of mine.  Senator, you’re no Jack Kennedy.”  Lloyd Bentsen

After recent trader/investor meetings, I realize almost everyone claims to be a contrarian.  Why is that?  I can only speculate, but I suspect it has to do with overconfidence and anchoring.  We know where prices were, and that gives us the confidence to expect they’ll return there in time.  I consider myself a trend follower, but my natural wiring leans contrarian.  How do I balance my personal yin and yang?

I’ve spent years wrestling with this issue, and have settled into a comfort level between my instinct and an evidence-based approach.  I put together a table that shows where I see edge in each time frame, and how they alternate between fading and following.  This is why countertrends exist, as there are players across many time frames operating with different motives at any given time.

I’ve also shown in the “My Needs” column how I measure each timeframe.  Because I lean contrarian, it takes zero convincing for me to assume that a 300 point rally will be followed by a pause or retracement.  That’s fine, because market history shows us that chasing these big days up or down is a sure way to the poorhouse.  However, extrapolating this “fade” mindset a few days could get me in trouble…assuming that 3 days of moderate gains means we’re due for a selloff  on day 4 does not test out, nor does it respect the way money flows in markets.  Since I have a natural aversion to buying after a few up days(or shorting after a few down days), I need objective data to override my own faulty reaction.

Fade a 4-6 week one way train?  No problem, fits my brain to a T.  However, carrying this fade mentality to the next time frame would put me on the wrong side of a tendency I believe to be true, that earnings momentum has persistency on a quarter to quarter basis.  Again, I use choose hard data over gut to measure this timeframe…it prevents me from acting with an “It’s too late” bias.

I doubt I’m alone in experiencing these natural reactions, it stems from the way our brains have evolved over time.  I’ve just taken the time to see where my “fade” instinct trumps data that says “follow”, and vice versa.  I have a memory of instances where my gut led me astray, and also where it helped…I discussed that in a recent post and also in an older one.  Assessing the “When?, Why?, and How?” I should listen to my gut allows me to match the proper tool with the proper job.

Identifying yourself as contrarian or follower, and defining the time frames in which you seek edge, are skills that must be addressed for market speculation.  I select ideas on a trend basis, but use contrarian mode in alternating frames for entry and exit. Incorporating multiple timeframes can be powerful, but only if you take the time to answer why you’ve done it.  Randomly jumping across the spectrum is a recipe for disaster…the time taken to extract the best of your brain and gut is a worthwhile exercise for traders on all levels.

Who says buying the first time a stock makes a 52 week high isn’t really the contrarian move anyway?

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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