There is a saying in investing, 'follow the whales'. However, there is also a simple idea that most of us forget that is to 'go against the herd'. Imagine a hundred fools walking in one direction. It is easier to just follow them if they're headed towards your target. But do you still follow if the path leads to a cliff?
We have seen the pollsters get it wrong, as well as the outcomes suggested by market gurus go the other way. What is bothersome is the frequency recently wherein the herd has gone wrong.
When the herd is wrong
The art of contrary thinking is simply going against where the herd is betting. As simple as it may sound, there are a few points worth noting.
1) Do your homework
Entering into a trade idea, or investing the contrarian way is still investing. Research and try to identify whether the herd is walking towards a cliff or an escalator.
2) Have a conviction
Let's dive into the past when fund managing was my game. I can recall a very nice example of a contrarian trade I took. Back in the days when Dixons Carphone was just Dixons, the company was scheduled to report its results and the brokers were all betting for a higher share price. The herd went into the direction where the brokers drew the path. Something was wrong.
I went into one of their busy stores for three consecutive Saturdays, watching the football and even taking to the cashiers – were they busy? Were they doing overtime? All I could make out was that the pre-result herd party was going to go bust soon.
I was a contrarian then, and yes it paid off. The stock price collapsed after the company reported its earnings.
But how do you find out where the herd is?
Go watch where the sentiment is. There are websites telling you how the market sentiment is for a particular stock, what the sentiment is for results. If you want to dive more in-depth, keep an eye on the open positions in the markets, look at what where market is tilted towards in the futures market.
And after you have access to sentiment information, check if it is too one-way. If everybody wants to sell, who will buy the underlying?
Look at how the gold fall ruined the herd
Starting 2016, everybody was bullish on gold. After all, anxieties over Donald Trump, Brexit and all the rest of it were doing the rounds. We had sentiment for XAU/USD crossing the 80% bullish mark. This was a perfect example – most of the sentiment tilted towards one side, and the bears rejoiced by selling opportunistically against the herd.
Fools rally in equities?
Look at the equity markets today. US Indices are hitting fresh all time highs and everybody is bullish. There are next to no bears left in town, and it makes one think "Is this a fool's rally before reality drives the markets lower?"
Nick "The Moose" Batsford, the founder of Tip TV, is a well-known and respected former City trader, with more than 25 years' experience in market trading and broking and a specialisation in short-term trading signals. Prior to setting up Tip TV, Batsford worked for various trading and brokerage companies, and eventually managed a hedge fund in London.