What is a Contrarian?
A contrarian is an investor that attempts to profit by deviating from conventional wisdom or 'the herd.'
How Does a Contrarian Work?
Generally, the basic premise behind contrarian investment methods is that the market or 'crowd' tends to overreact to information in the short-term, which causes price increases and decreases to be overdone and allows savvy investors to profit.
Contrarians zig when everyone else zags. They tend to buy when everyone else is selling, sell when everyone else is buying. The result is that the contrarian often buys a cheap security that everyone else is calling a dog and sells a security that everyone else is clamoring to get into. Contrarians often look for stocks with low price-to-earnings ratios. In fact, there is little difference between value investing and many forms contrarian investing.
The Dogs of the Dow popular contrarian strategy whereby investors purchase the highest-yielding stocks in the Dow Jones Industrial Average (DJIA). Remember, a stock has to pay a relatively high dividend and have a relatively depressed stock price to have a high dividend yield. When any of the investor's stocks rise in price so much that they are no longer in the top ten, he/she sells them, capturing the gain.
Why Does a Contrarian Matter?
It is important to note that contrarian investing often works best for investors who have thoroughly analyzed the fundamentals of the companies they invest in. Companies with solid management teams, innovative products, efficient processes, and good profit margins can often weather periods of unpopularity.