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Greetings, fellow Pro-fundity team members -
8-6-99 Page
- It has been said that a contrary person would be found upstream if drowned in a river. This describes a group of investors known as "Contrarians." The term "contrary" itself is negative. A thesaurus lists synonyms as "contradictory, opposite, counter, incompatible." What value can a "Contrarian Investor" bring to provident investing? What can we learn from this group of investors to increase our chances for success? This Guidepost will introduce this subject and seek answers to these questions.
- What is a contrarian investor? A basic answer is be contrary, for instance, buy on bad-news, sell on good-news. The number one trading rule for contrarian investors is the "down-by-half rule;" A stock cannot be bought unless it is down by at least 50% from its 52-week high. That rule by itself is not sufficient, but it does say that if a stock is down by half it has fallen out of favor by investors. That is where the contrarian steps in. "Go where the crowd ain't!"
- Other contrarian rules pick up at this point, "What else is necessary before buying a stock?" These will be discussed later, but lets examine this first rule. Research has repeatedly shown that hot stocks cool off and cold stocks tend to get hot. In the real world, however, most people won't buy a falling stock, conditioned to believe they should be avoided. It is easier to go along with the crowd and avoid thinking about anything. The result is the majority of investors end up buying at tops and selling at bottoms. It seems many investors feel more comfortable with the crowd, whether money is made or not.
- An important study examined the difference in the performance of stocks experiencing "good news" and those experiencing "bad news." This study compared the performance of stock- price movements on the AMEX and NYSE over an 18 year period. Good news was defined as a 50% rise in price, bad news a 50% drop. Stocks with "good news" performed substantially worse than the overall market the following year. "Bad news" stocks did the opposite, outperforming the market in the year afterward. But there was a big difference in the nature of these "good" and "bad" performances.
- This is the basis of the contrarian's first rule. Stocks that are down by 50% have a tendency to rise. We will examine other contrarian rules in coming Guideposts. Stay tuned.
This week's Editorial Guidepost:
The poor performance following the 50% rise in price did not happen immediately but was spread out over a period of almost a year. Whereas, the rebound following "bad" news occurred in the five weeks following the event, with most of the impact concentrated in the first week.
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