What is contrarian investing? Have you ever heard this question.. “When those who aren’t involved with the stock market are talking about stocks, it’s time to sell”? This famous phrase is an example of contrarian investing and how to use the theory of contrary opinion in the trading world
What is the theory of contrary opinion?
Is a psychological theory used in trading? It tries to expect a change in the trend in the price of a financial asset..even though market sentiment or technical and/or fundamental indicators indicate a contrary position.
Due to the features of trading, this change of direction will be stronger at the beginning of the movement. Traders limit losses by placing a stop loss. Therefore, when there is a change in trend, these orders start to jump and a domino effect happens that sinks or triggers the value of the financial asset.
Accordingly, the potential loss, if the trend continues, is little compared to the potential benefit of speculating on a possible change in direction.
Is the theory of contrary opinion rational?
Psychology is only one of the sides that can affect operations. 3 out of 4 little investors lose money with their trading. Some people might think that if a small investor wants to make a profit from
trading, then according to the theory of contrary opinion, all they have to do is trade in the opposite direction as most of the market. However, that logic does not lead to the desired outcomes.
Is the theory of contrary opinion economical?
The price of any asset will be controlled by its supply and demand.
What will happen if the price of an asset rises and the rest of the factors remain constant?
Under this assumption, the market will go out of balance and the corrective forces will tend to restore the initial balance.
As the price rises, there will be more producers who want to sell their product but very few interested buyers. This will make an excess supply and producers will have to reduce the price of the asset to sell that surplus.
How will this new price be kept in balance?
It will be essential to move the supply or demand curves.
What usually happens in reality?
The number of investors in the market usually rises, shifting the demand curve to the right. These new participants enter the market attracted by the positive predictions of this financial asset and are identified by having less experience in the sector.
Purchases by these new investors make the asset price higher and improve returns for investors already in the market. This process aims to accentuate over time. The joy often moves from financial
markets to the media. Everyone predicts to have benefits. Here is where we can see the events expected by the theory of contrary opinion unfold.
Expert traders find that these assets have lost their appeal as they offer increasingly worse returns on investment. Doubts start to arise and these traders change their position from BULLISH to BEARISH producing a fall in the price of the asset.
This fall causes losses in the majority of small investors who had chosen for the opposite effect and uncertainty starts to take over the market. Fear, being a very volatile sentiment, spreads like wildfire, and the market changes its position fastly.
the price of the asset after the fall does not return to the initial point, since more participants in the market have been trapped and are confident that the price will recover.
?Can the theory of contrary opinion be proven
There are also some associations gathered. The American Association of Individual Investors (AAII). This association conducts a weekly survey among its members, where they are asked if they believe that the S&P 500 will increase, fall or stay stable in the next 6 months.
With such market data, we can evaluate whether the changes in the market can be described by the theory of contrary opinion.
How can you avoid getting trapped?
How do you know if the theory of contrary opinion will truly predict the movements in the market..the price will drop, and you’ll get trapped?
Many leading indicators can be used as signals for these possible changes. Some of the most prominent are:
Fundamentals: Chicago board options exchange (CBOE) & Volatility Index (VIX index).
How to use this theory in a real market?
An example of using the theory of contrary opinion can be found in the new evolution of the price of silver against the US dollar.
According to the market, unity is in an upward trend since its demand is increasing and its supply is decreasing.
Increasing demand pushes prices up. This is caused by several factors, including:
The features of silver as a refuge value are making its demand rise in the face of the advance of the coronavirus after the Christmas holidays.
Silver is an important element in the production process of the so-called “green revolution”.
in addition.. it is expected that its supply will be reduced due to the reduction in the production of this material, which will also raise the prices.
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