“Be fearful when others are greedy and be greedy when others are fearful.” This quote by Warren Buffett that perfectly captures the contrarian approach. A contrarian trader is someone who goes against the grain. They don’t follow the crowd. Instead, they move in the opposite direction on the assumption that crowd sentiment is wrong.
But what does this mean in trading? Well, most traders are likely to monitor and then follow prevailing market trends. A contrarian trader will do the contrary. When most traders are going long, they’ll likely be going short, and vice versa.
As Warren Buffett famously said, “Be fearful when others are greedy and be greedy when others are fearful.” This quote perfectly sums up the mindset of a contrarian trader, who seeks opportunities where others hesitate.
In fact, during the 2008 financial crisis, it was Buffett who reportedly urged investors to invest in American stocks. So confident was he, that he acquired shares in American firms like investment bank Goldman Sachs Group, Inc.
A decade later, his advice proved accurate with Goldman Sachs stock soaring by around 239% between 2008-2018. Other well-known investors considered contrarians include the likes of Charles Munger, Michael Burry, George Soros, Sarah Klarman, David Einhorn, and Carl Icahn.
The principles of contrarian trading
A contrarian approach to trading is primarily based on the premise that market trends can become exaggerated so rather than do what the masses do, a contrarian trader will simply do the reverse.
They look to unpopular or undervalued assets for trading opportunities, in the anticipation that a future reversal in sentiment will occur. The principles behind contrarian trading can be applied to multiple asset classes, be it stocks, commodities, forex, etc.
What are some of the ways that contrarian traders come to trading decisions?
There are certain factors that contrarian traders will be on the lookout for while making trading decisions. This includes extreme levels of sentiment.
The idea is that when bullish sentiment is at its strongest, a contrarian trader might view it as a sign that the market is overbought and likely to experience a correction.
By the same token, when bearish sentiment hits its peak, the contrarian trader might view it as a chance to go long, expecting the market to be oversold and heading for a rebound.
A contrarian trader is also likely to use a mix of techniques to identify market trends like:
- Broader fundamental analysis
- Technical analysis indicators and signals (e.g. Relative Strength Index (RSI), Moving Averages, Support and Resistance levels, MACD)
- Sentiment indicators (e.g. Volatility Index (VIX), COT Report, Bullish/Bearish Sentiment surveys, etc)
- Competitor analysis
- Revenue and profit margins
What does it take to become a contrarian trader?
A contrarian trader is likely to enter a market when others feel negative about it. It is also common to see a contrarian trader seeking undervalued assets to buy low and eventually sell high. To makes these sorts of trading decisions that go against what others in the market are pushing you to do requires incredibly strong mental resilience and a deep understanding of the financial markets.
While contrarian traders seek to leverage emotional extremes in the market, they also must know how to not succumb to herd mentality. This requires confidence and trust in their understanding of how the market will inevitably perform.
Contrarian traders are usually people with patience, focus, and resolve. As we’ve already suggested, the ability to go against what the masses are doing, particularly if the market one can see the market moving in a definitive direction, is incredibly difficult. Contrarian traders typically have the patience to wait for sentiment highs and lows to show themselves before entering or exiting a trade.
Contrarian trading is likely to come with a significant level of risk. The trader is doing the exact opposite of what others are. There is no certainty that this move, this decision, will always be correct. This means measures have to be put in place for the trader to protect their funds. There are many ways or tools that the trader will use to safeguard their money.
Some of the most popular include:
- Position sizing: this refers to the amount of money the contrarian trader will invest in a position. The value usually depends on the trader’s budget and level of expertise. It may also be based on the level of risk they’re willing to incur on a single position. On average, a trader will stick to 1-2% of their total capital.
- Stop-loss order: another risk management technique a contrarian trader is likely to use is stop-loss orders. Setting a stop-loss order is essentially setting a predetermined point of exiting a losing position. This is to ensure that losses don’t become magnified. Stop-loss orders also offer some peace of mind as the trader knows that as soon as the preestablished level is reached, the order will be triggered, limiting losses.
- Accurate timing of trades: timing is everything for a contrarian trader. This requires expert technical analysis skills to be able to identify accurate entry or exit points, to mitigate the risk of making adverse trading decisions.
- Portfolio diversification: contrarian trading can be applied to a variety of financial instruments. A contrarian trader may consider spreading their capital across different trades as opposed to investing it all into a single asset class. This is to avoid the impact of being wrong on a single trade and losing all your money.
Learn more about becoming a contrarian strategy
Engaging in some form of ongoing education is an important component of any trading strategy, including contrarian trading. There are also many ways to acquire knowledge about trading fundamentals.
For one, the internet is a great source of diverse trading related educational resources. Saying that, ensuring that you are obtaining credible information from a credible source is key, so do your homework.
Additionally, most reputable brokers strive to help their traders become more skilled, taking them from beginner to expert level. As a result, brokers are likely to offer an extensive range of learning tools to widen your scope of knowledge.
A broker like T4Trade for instance provides its brokers with a mix of insightful blogs, podcasts, webinars, e-books, videos, Calculadoras de trading, and an incredibly useful Economic Calendar with which you can track vital economic indicators in real time.
Contrarian traders may also join online community forums to meet and engage with worldwide traders and share insights, ideas, and strategies.
Sign up for a demo trading account
If you are new to trading, or simply someone looking for a way to test different trading strategies, regardless of complexity, consider signing up for a demo trading account.
A demo account gives you access to a simulated trading environment in which you can practice trading. You can conduct analysis and enter and exit trades using virtual money.
You can learn more about how to navigate the trading platform, which is likely to be MetaTrader 4, probably the most popular platform in the world and a firm favourite amongst global traders.
Contrarian Trading with T4Trade
T4Trade is a globally recognized broker, serving clients across the world. It provides exceptional 24/5 multilingual customer support, advanced trading platforms, and adaptable trading conditions. The broker is an excellent resource for traders seeking to enhance their forex trading knowledge in an accessible and engaging way.
T4Trade offers a diverse selection of educational materials, including videos, podcasts, eBooks, webinars, and on-demand content, all curated by in-house experts to cater to traders of all levels.
With access to a wide range of trading instruments across six asset classes, T4Trade clients benefit from flexible leverage, competitive spreads, fast trade execution, and smooth deposit and withdrawal processes. Additionally, traders can select from various account types tailored to their unique needs and preferences.
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