INVESTMENT EXTRA: Betting against the herd

By CLEM CHAMBERS
Updated: 17:16 EST, 11 June 2010

Investment fashions come and go but one style of investing never changes: contrarian. It has been, and remains, a profitable way to trade.

It takes a perverse streak to buy Barclays at 47p (current price 290.85p). It takes eccentricity to buy Pendragon at 2p then sell it a few months later for 30p. These are examples of contrarian investing.

We all want to buy at the bottom of the market and sell at the top. How­ever, few investors realise this actually equates to doing the exact opposite of what everyone else is doing.

Buying at the bottom involves buy­ing when no one else dares and then selling at the top means selling when everyone else thinks the share is brilliant.

This idea has always been attractive to me, even as a child I could see his­tory packed with spectacular failures of the majority view, whether in sci­ence, politics or religion.

In fact it is hard to find received wisdom that actually turns out to be correct in any period in the past, so why should it be different now? Once you can rebel against the opin­ions of the majority, suddenly contrarian investing becomes a lucrative possibility.

Why buy Pendragon at 2p? A contrarian will think: if it doesn’t go broke, this company will go to 20p (it went to 40p). Therefore I can buy a company like that and be wrong a lot and on average still make a fat profit from an occasional survivor.

Barclays at 47p? The contrarian thought is: ‘Everyone is panicked and they think Barclays is the next HBOS or RBS, they may be wrong.

‘If I dig into the facts and the herd is wrong I will make a killing.’

Even if I feel it’s a 50/50 chance Barclays will go under, if it doesn’t the share price will recover to £5 in a few years. The contrarian thought leads to an even-money bet with a potential 1000% payout.

At the extreme end of contrar­ian investing is buying crashing stocks. Right now BP has slumped. BP is an enormous company and a contrarian will start getting interested in buy­ing, because everyone is so upset with the company over the vast disaster for which it is responsi­ble in the Gulf of Mexico that it might be getting cheap.

But there are too many people looking at it and thinking: ‘Gosh it looks cheap.’ So as a contrarian you won’t bother just yet.

A fall to £2 a share (current BP price 391.9p) and the contrarian starts to get interest. The risk-reward looks better. Think Bar­clays at 47p.

Warren Buffet, the famed inves­tor, said: ‘Buy when there is fear in the market and sell when there is greed.’

This is pure contrarian think­ing. In the end most situations return to normal and when they do the contrarian is left with the profits of being brave in the bad times.

As a contrarian I know good times come just before bad times and I then want to sell and be safe. I know bad times are fol­lowed by good and when things are tough I want to be loading up while the price is low.

The past few days are a perfect example of how money can be made by being contrarian. The Euro crisis was going to flatten Europe and cast the world econ­omy into the pit of economic hell. A few days later and the markets appear to be making a comeback.

Will the contrar­ian who bought the FTSE100 below 5000 recently be smiling at the end of the year? I think so. Will the members of the herd that stormed out of shares in May? I doubt it.

A contrarian doesn’t take tips from friends. They sell when eve­ryone says buy – and buy when everyone says sell.

They don’t believe the news and will do the opposite of what eve­ryone is advising.

The bigger the crash the more they want to buy. Yet it is not a blind response.

A contrarian like me looks for these signals to start sanity-checking the reasons for the panic. Very often the reason­ing behind the panic is greatly exaggerated. This is where the opportunity lies.

So today, the pound is very weak and the Yen incredibly strong. What does a contrarian think? Clearly, the pound will rise and the yen will crash. When eve­ryone tells me I’m a fool, I smile.