As much as we try to> stand out, we have an inescapable yearning to fit in. Psychologist Abraham Maslow called it the "belonging need," the instinctual human desire to be an accepted part of the group, family or club. That impulse, unfortunately, hurts us as investors, where our goal is to avoid the herd, not be part of it.
A contrarian investment approach, by definition, purposefully repeals that innate longing, which makes it far from comfortable or fruitful, for a while at least. Recall it was during the height of the 1990s tech bubble when Louis Rukeyser famously dumped analyst Gail Dudak from his panel of market "elves" on "Wall Street Week" for her bearish forecasting; the market peaked just four months later.
Far from being celebrated or followed, contrarians are more often ridiculed or simply ignored.
To understand what a contrarian is, it's important to know what they are not. We mistakenly think of any investor fighting the tape as being contrarian. If the market drops, so the thinking goes, it's because the public is selling, which is exactly when the opportunistic contrarian steps in. Yet as we wrote a few years back, the law of supply and demand is also that of demand and supply. Markets are just as likely to drop because there are too few buyers as they are if there are too many sellers. Just because the market dips, it doesn't mean the public is jumping out.
And being a contrarian isn't about what you buy, it's about how you think. To that end, he shouldn't focus on the worst-performing stocks quite the contrary. Instead, it's better to single out the strongest but most ignored areas, opting specifically for those risks that seem, well, a little crazy.
For example, open interest in the metal palladium has jumped sharply thanks to a sustained rise and new recently launched funds like ETFS Physical Palladium (PALL)
It's uncomfortable to invest in a stock without an obvious reason. It's unnerving to put your limited resources into names like Mitsui & Co. (MITSY)
Yet it's that dissonance and uncertainty which the speculator is paid to assume. And over time, as a security's price action slowly but persistently confirms your outlook, positions like commodities, emerging markets and foreign exchange, once considered "reckless," are ultimately thought of as quite rational and sane.
By then, the contrarian has already moved on to the next trade.
Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC. At the time of writing, Hoenig's fund held positions in many of the securities mentioned.