Contrarian investing is a strategy rooted in the principle of going against prevailing market sentiment. It involves identifying opportunities where the majority of investors appear to be acting emotionally or irrationally, either through excessive optimism or undue pessimism.
A contrarian investor deliberately takes the opposite position, buying when others are fearful and selling when others are exuberant, under the belief that market prices often swing to extremes that are not justified by fundamentals.
DEFINING CONTRARIAN THINKING IN FINANCIAL MARKETS
At its core, contrarian investing is based on the observation that financial markets are influenced not only by economic data and corporate performance but also by human psychology. In practice, this means that assets can become significantly mispriced due to herd behaviour.
When a large number of investors act in the same direction – such as pouring money into a popular sector or panic-selling during a downturn – asset prices can deviate from their intrinsic value. Contrarians seek to capitalise on these dislocations by taking positions that reflect long-term fundamentals rather than short-term sentiment.
This approach contrasts with momentum or trend-following strategies, which rely on riding prevailing market movements. Whereas traditional investors may prefer to invest in popular sectors or growth stories that have already performed well, contrarians look for areas that are underappreciated, undervalued or neglected. Their focus is often on assets or markets that have fallen out of favour, with the expectation that sentiment will eventually normalise and prices will revert.
THE HISTORICAL ROOTS OF CONTRARIANISM
Contrarian investing has a long and established history. One of its earliest advocates was Sir John Templeton, who built a global investment empire by buying during times of peak pessimism.
In 1939, at the outset of World War II, Templeton famously bought shares in every NYSE-listed company trading below $1, including many that were near bankruptcy. While many of those bets failed, the overall return on his portfolio was substantial, validating the idea that extreme fear often creates opportunity.
Other notable figures, such as Benjamin Graham and later David Dreman, developed the idea of investing in stocks with low price-to-earnings or price-to-book ratios, which often correlated with negative sentiment. These investors demonstrated that out-of-favour companies, though perceived as risky, frequently produced superior long-term returns when bought at deep discounts to their intrinsic value.
Over time, academic studies began to support these findings, showing that low-expectation stocks often outperform their high-expectation counterparts due to reversion to the mean.
THE PSYCHOLOGY BEHIND CONTRARIAN STRATEGIES
The contrarian approach is deeply grounded in behavioural finance. Human beings are naturally prone to psychological biases such as herd behaviour, loss aversion and recency bias. These tendencies lead investors to overreact to news, chase performance and avoid assets that have recently underperformed.
During market upswings, fear of missing out (FOMO) can drive excessive optimism, inflating prices beyond reasonable valuations. In downturns, fear and uncertainty can cause indiscriminate selling, driving prices below intrinsic value.
Contrarians aim to exploit these behavioural patterns by maintaining a disciplined, independent outlook. Rather than relying on consensus forecasts or media narratives, they often turn to sentiment indicators, valuation metrics and historical context to assess where markets may have overreacted.
This requires patience and mental resilience, as contrarian positions may underperform in the short term and can attract criticism during periods of market euphoria or panic.
CONTRARIANISM AS A STRATEGIC FRAMEWORK
Contrarian investing is not about disagreeing with the market for its own sake. It is a structured approach that involves identifying where sentiment has diverged significantly from reality. Successful contrarians do not simply buy what is unpopular: they focus on assets that are fundamentally sound but temporarily mispriced. The goal is not to bet against the crowd blindly, but to anticipate when sentiment will shift back towards rationality, allowing valuations to correct.
This approach can be applied across asset classes, from equities and bonds to commodities and property. It can also function within different time horizons, from short-term tactical trades to long-term value investing. In all cases, the unifying principle remains the same: exploit emotional overreactions in the market to uncover value where others see only risk.
Understanding contrarian investing requires more than recognising patterns, demanding a willingness to act when others hesitate, backed by rigorous analysis and a strong grasp of market psychology. As the series continues, we will examine the tools, strategies and disciplines that enable contrarians to navigate volatile markets and uncover opportunities where few others are looking.
To learn more about contrarian investing, visit Orbis Investments' Contrarian Investing Playbook.
This Trustnet Learn article was written with assistance from artificial intelligence (AI). For more information, please visit our AI Statement.