In the stock market, contrarians don't like to run with the crowd.
It's not bad strategy at all, really, because the crowd is often wrong on Wall Street. Warren Buffet once said: "You pay a very high price in the stock market for a cheery consensus.
Indeed, excessive bullishness is often seen at market tops, just as excessive bearishness is often seen at market bottoms. And when euphoria starts to build in a stock, it often happens near a top.
Baron Rothschild, a distinguished member of the wealthy banking family that bears his last name, is credited with saying, "Buy when there's blood in the streets." In other words, buy when no one else is buying.
But there's one problem with this strategy, at least when it comes to individual stocks. It usually entails buying a stock that institutions have been selling. There's blood in the streets when a stock is getting taken apart in heavy , breaking through key support levels. But this is not the time to be buying — not when institutional investors are liquidating a position in spades.
Their reasons for selling run the gamut. The broad market might be acting weak, or there are legitimate concerns about growth prospects at the company.
It can take a long time for a stock to recover from significant institutional selling, especially if it's a true leading growth stock. You can sit around for years and hope a former leader comes back. Most do not.
"Holding and hoping" can result in significant damage to a portfolio. If you bought Mellanox Technologies (MLNX) late last year when there was blood in the streets, you'd be sitting on a significant loss. Same with SolarWinds (SWI) when it started to sell off earlier this year.
A contrarian view can be helpful, however, when looking for signs of a market bottom. That's because excessive bearishness has often been seen at or near market bottoms. When the economy was coming out of recession, the S&P 500 confirmed a new uptrend on March 12, 2009, (1) rising 4.1% on the fifth day of its rally attempt in higher volume.
Sentiment wasn't pretty at the time. The Investors Intelligence survey of newsletter writers showed the bulls at 26.4%, near a five-year low of 21.3%. The bears, meanwhile were near a five-year high at 47.2%.
When the U.S. invaded Iraq in March 2003, there was blood in the streets — not only in Iraq but also in the stock market. Market sentiment was generally poor after the Nasdaq slumped 32% in 2002. No one wanted to go near stocks.
But a bottom occurred that same month. The Nasdaq surged 3.9% in higher volume on March 17, the fourth day of its rally attempt. The bullish action confirmed a new uptrend, well documented by the next day's Big Picture column in IBD. The Nasdaq rallied 50% by year's end.