When markets are in free fall, there may be a substantial amount of recommendation that’s meted out to traders, and one is to simply purchase the dip, i.e., purchase crushed down shares, within the hope that they are going to get better, or all the market, whether it is down. “Shopping for the dip” falls right into a broad group of funding methods that may be labeled as “contrarian”, the place traders act in distinction to what the remainder of the market is doing on the time, shopping for (promoting) when the overwhelming majority are promoting (shopping for) , and it has been round via all of market historical past. There are strands of analysis in each behavioral finance and empirical research that again up contrarian methods, however as with all the pieces to do with investing, it comes with caveats and constraints. On this submit, I’ll posit that contrarian investing can take totally different varieties, every based mostly on totally different assumptions about market conduct, and current the proof that we’ve got on the successes and failures of every one. I’ll argue that even if you’re swayed intellectually by the arguments for going towards the group, it could not be just right for you, if you’re not psychologically attuned to the stresses and calls for that contrarian methods deliver with them.
Contrarianism – The Completely different Strands
All contrarian investing is constructed round a typical theme of shopping for an funding, when its worth goes down considerably, however there are huge variations in how it’s practiced. Within the first, knee-jerk contrarianism, you employ a bludgeon, shopping for both particular person firms or all the market when they’re down, on the expectation that you’ll profit from an inevitable restoration in costs. Within the second, technical contrarianism, you purchase beaten-up shares or all the market, however provided that charting or technical indicators assist the choice. Within the third, constrained contrarianism, you purchase the shares which might be down, however provided that they move your screens for qualify and security. Within the fourth, opportunistic contrarianism, you employ a worth markdown as a chance to purchase firms that you’ve all the time wished to carry, however had not been in a position to purchase as a result of they had been priced too excessive.
1. Knee-jerk Contrarianism
The best and most direct model of contrarian investing is to purchase any traded asset the place the worth is down considerably from its highs, with the asset generally being a person firm, generally a sector and generally all the market. Implicit on this technique is an absolute perception in imply reversion, i.e., that what goes down will virtually all the time return up, and that purchasing on the crushed down worth and being prepared to attend will due to this fact repay.
The proof for this technique comes from many sources. For the market, it’s usually constructed on papers (or books) that take a look at the historic information on what fairness markets have delivered as returns over lengthy durations, relative to what you’ll have made investing elsewhere. Utilizing information for the US, a market with the longest and most dependable historic information, you’ll be able to see the substantial payoff to investing in equities:
It doesn’t matter what time interval you employ to your time horizon, shares ship the very best returns, of all asset courses, and there some who take a look at this document and conclude that “shares all the time win in the long run”, with the implication that it is best to keep totally invested in shares, even via the worst downturns, in case you have a fairly very long time horizon. These returns to purchasing shares turn out to be larger, once you purchase them when they’re cheaper, measured both via pricing metrics (low PE ratios) or after corrections. There are two issues with the conclusion. The primary is that there’s choice bias, the place utilizing historic information from the US, one of the crucial profitable fairness markets of the final century, to attract common conclusions in regards to the danger and returns of investing in equities will lead you to underestimate fairness danger and overestimate fairness returns. The second is that, even with US equities, an investor who purchased shares simply earlier than a serious downturn must wait a very long time earlier than being made entire once more. Thus, traders who put their cash in shares in 1929, simply forward of the Nice Melancholy, wouldn’t have recovered till 1954.
With particular person shares, the strongest backing for getting the dip comes from research of “loser” shares, i.e., shares which have gone down probably the most over a previous interval. In a broadly cited paper from 1985, DeBondt and Thaler labeled shares based mostly upon inventory worth efficiency within the prior three years into winner and loser portfolios, with the highest fifty performers going into the “winner” portfolio, and the underside fifty into the “losers portfolio”, and estimated the returns you possibly can have made on every group within the following metropolis months:
As you’ll be able to see, the loser portfolio dramatically outperforms the winner portfolio, delivering about 30% extra on a cumulative foundation than the winner portfolio within the thirty six months after the portfolios are created, which DeBondt and Thaler argued was proof that markets overreact. A couple of decade later, Jegadeesh and Titman revisited the research, with extra granular information on time horizons, and located that the outcomes had been reversed, if you happen to shorten the holding interval, with winner shares persevering with to win over the primary 12 months after portfolio creation.
The reversal finally kicks in after a 12 months, however over all the time interval, the winner portfolio nonetheless outperforms the loser portfolio, on a cumulative foundation. Jegadeesh and Titman additionally famous a skew within the loser portfolio in the direction of smaller market cap and lower-priced shares, with increased transactions prices (from bid-ask spreads and worth impression). As different research have added to the combo, the consensus on winner versus loser shares is that there isn’t any consensus, with proof for each momentum, with winner shares persevering with to win, and for reversal, with loser shares outperforming, relying on time horizon, and questions on whether or not these extra returns are massive sufficient to cowl the transactions prices concerned.
Setting apart the blended proof for the second, the most important hazard in knee-jerk contrarian investing on the market stage is that purchasing the dip available in the market is akin to catching a falling knife, since that preliminary market drop is usually a prelude to a a lot bigger unload, and to the extent that there was an financial or basic motive for the unload (a banking disaster, a extreme recession), there could also be no close to time period bounceback. With particular person shares, that hazard will get multiplied, with traders shopping for shares which might be being bought off to for professional causes (a damaged enterprise mannequin, dysfunctional administration, monetary misery) and ready for a market correction that by no means comes.
To look at the sorts of firms that you’d put money into, with a knee-jerk contrarian investing technique , I checked out all US shares with a market capitalization exceeding a billion {dollars} on December 31, 2024, and located the businesses that had been the most important losers, on a p.c foundation, between March 28 and April 18 of 2025:
You’ll be aware that know-how and biotechnology corporations are disproportionately represented on the record, however that’s the by-product of a bludgeon method.
2. Technical Contrarianism
In technical contrarianism, you begin with the identical foundation as knee-jerk contrarianism, by shares and markets which have dropped considerably, however with an added requirement that the worth has to fulfill a charting or technical indicator constraint earlier than changing into a purchase. Whereas there are various who consign technical evaluation to voodoo investing, I imagine that charting patterns and technical indicators can present indicators of shifts in temper and momentum that drive worth actions, no less than within the close to time period. Thus, you’ll be able to view technical contrarianism as shopping for shares or markets when they’re down, however provided that the charts and technical indicators level to a shift in market temper.
One of many issues with testing technical contrarianism, to see if it really works, is that even amongst technical analysts, there appears to be no consensus as to the very best indicator to make use of, however broadly talking, these indicators may be based mostly on both worth and/or quantity actions. They vary in sophistication from easy measures like relative power (the place you take a look at proportion worth adjustments over a interval) and shifting averages to complicated ones that mix worth and quantity. In latest many years, traders have added pricing in different markets to the combo, with the VIX (a traded volatility index) in addition to the relative pricing of places and calls within the choices market being utilized in market timing. In sum, all of those indicators are directed at measuring worry available in the market, with a “market capitulation” considered as an indication that the market has bottomed out.
With market timing indicators, there may be analysis backing up using VIX and buying and selling quantity as predictors of market actions, although with substantial error.
Because the VIX rises, the anticipated return on shares in future durations goes up, albeit with a lot increased volatility round these anticipated returns. It is ironic that a few of the greatest defenses of technical evaluation have been supplied by lecturers, particularly of their research of worth momentum and reversal. Lo, Wang, and Mamaysky current a reasonably convincing protection of technical evaluation from the attitude of economic economists. They use every day returns of shares on the New York Inventory Trade and NASDAQ from 1962 and 1996 and make use of subtle computational methods (reasonably than human visualization) to search for pricing patterns. They discover that the commonest patterns in shares are double tops and bottoms, adopted by the broadly used head and shoulders sample. In different phrases, they discover proof that a few of the commonest patterns utilized by technical analysts exist in costs. Lest this be trigger for an excessive amount of celebration amongst chartists, additionally they level out that these patterns provide solely marginal incremental returns (an educational code phrase for actually small) and provide the caveat that these returns might not survive transaction prices.
3. Constrained Contrarianism
In case you are within the old-time worth investing camp, your method to contrarian investing will replicate that worldview, the place you’ll purchase shares which have dropped in worth, however provided that they meet the opposite standards that you’ve for good firms. Briefly, you’ll begin with an inventory of crushed up shares, after which display them for excessive profitability, robust moats and low danger, hoping to separate firms which might be low-cost from people who should be low-cost.
As a constrained contrarian, you’re hoping to keep away from worth traps, each worth investor’s nightmare , the place an organization appears to be like low-cost on a pricing foundation (low PE, low worth to ebook) and proceeds to turn out to be even cheaper after you purchase it. The proof on whether or not screening helps keep away from worth traps comes largely from research of the interaction between proxies of worth (equivalent to low worth to ebook ratios) and proxies for high quality, together with measures for each working/capital effectivity (margins and returns on capital) and low danger (low debt ratios and volatility). Proponents of high quality screens be aware that whereas worth proxies alone not appear to ship extra returns, incorporating high quality screens appears to protect these extra returns. Analysis Associates, an funding advisory service, checked out returns to pure worth screens versus worth plus high quality screens and presents the next proof on how screening for high quality improves returns:
The proof is supportive of the speculation that including high quality screens improves returns, and does so extra for shares that look low-cost (low worth to ebook) than for costly shares. That mentioned, the proof is underwhelming when it comes to payoff, no less than on an annual return foundation, although the payoff is larger, if you happen to think about volatility and estimate Sharpe ratios (scaling annual return to volatility).
Whereas a lot of the analysis on high quality has been constructed round worth and small cap investing, the findings may be extrapolated to contrarian investing, with the lesson being that reasonably than purchase the most important losers, you ought to be shopping for the losers that move screening checks for top profitability (excessive returns on fairness or capital) and low danger (low debt ratios and volatility). That will present a modicum of safety, however the issue with these screens is that they’re based mostly upon historic information and don’t seize structural adjustments within the financial system or disruption within the trade, each of which haven’t but discovered their means into the basics which might be in your screens.
To supply simply an illustration of constrained contrarianism, I once more returned to the universe of about 6,000 publicly traded US shares on April 18, 2025, and after eradicating corporations with market capitalizations lower than $100 million (with the rationale that these firms can have extra liquidity danger and transactions prices), I screened first for shares that misplaced greater than 20% of their market capitalization between March 28 and April 18, after which added three worth screens:
- A PE ratio lower than 15, placing the inventory within the backside quintile of US shares as of December 31, 2024
- A dividend yield that exceeded 1%, a paltry quantity by historic norms, however making certain that the corporate was dividend-paying in 2024, a 12 months by which 60% of US shares paid no dividends
- A internet debt/EBITDA ratio of lower than two, dropping it into the underside quintile of US firms when it comes to debt load
The six firms that made it via the screens are under:
I’m certain that if you’re a worth investor, you’ll disagree about each the screens that I used in addition to my minimize offs, however you’re welcome to experiment with your personal screens to search out bargains.
4. Opportunistic Contrarianism
In a fourth variant of contrarian investing, you employ a market meltdown as a chance to purchase firms that you simply have all the time wished to personal however couldn’t as a result of they had been overestimated earlier than the worth drop, however look below priced after. The perfect place to begin an evaluation of opportunistic investing is with my submit on why good firms aren’t all the time good investments, with the primary being decided by all the issues that go into separating nice companies from dangerous companies, together with progress and profitability, and the second by the worth it’s important to pay to purchase them. In that submit, I had an image drawing the distinction between good firms and good investments:
Put merely, most nice firms are impartial and even dangerous investments, as a result of the market costs them to be nice. A 12 months in the past, after I valued the Magazine Seven inventorys, I argued that these had been, for probably the most half, nice companies, with a mixture of progress at scale, excessive profitability and deep moats, however that on the costs that they had been buying and selling they weren’t nice investments.
I additionally argued that even nice firms have their market travails, the place for durations of time, traders lose religion in them and drive their costs down not simply to worth, however under. It occurred to Microsoft in 2014, Apple in 2017, Nvidia in 2018, Tesla at a number of occasions within the final decade, and to Fb, on the peak of the Metaverse fiasco. Whereas these corrections had been attributable to company-specific information tales and points, the identical course of can play out, when you will have vital market markdowns, as we’ve got had over the previous couple of weeks.
The method of opportunistic contrarianism begins nicely earlier than a market correction, with the identification of firms that you simply imagine are good or nice companies:
On the time that you simply first worth them, you’re prone to discover them to be over valued, which can undoubtedly be frustration. You could be tempted to play with the numbers to make these firms look undervalued, however a greater path is to place them in your record of firms you want to personal, and depart them there. Throughout a market disaster, and particularly when traders are marking down the costs of all the pieces, with out discriminating between good and dangerous firms, it is best to revisit that record, with a caveat that you can’t examine the post-correction worth to your pre-crisis valuation of your organization. As a substitute, you’ll have to revalue the corporate, with changes to anticipated money flows and danger premiums, given the disaster, and if that worth exceeds the worth, you should purchase the inventory.
Contrarian Investing: The Psychological Exams!
Within the summary, it’s straightforward to grasp the enchantment of contrarian investing. Each behavioral and empirical analysis determine the existence of herd conduct in crowds, and level to tipping factors the place crowd knowledge turns into crowd insanity. A rational decision-maker within the midst of animal spirits might really feel that she or he has a bonus on this setting, and rightly so. That mentioned, shopping for when the remainder of the market is promoting takes a mindset, a time horizon and a stronger abdomen than most of us should not have.
- The Mindset: Investing towards the market is not going to come simply to those that are simply swayed by peer stress, since they should purchase, simply as different traders (the peer group) shall be promoting, and infrequently in firms that the market has turned towards. There are some who march to their very own drummers, prepared to take a path that’s totally different from the remaining, and these are higher suited to being contrarians.
- The Time Horizon: To be a contrarian, you do not all the time want a very long time horizon, since correlations can generally occur rapidly, however it’s important to be prepared to attend for a protracted interval, if that’s what is critical for the correction. Comparatively few traders have this capability, since it’s decided as a lot by your circumstances (age, well being and money wants) as it’s by your persona.
- The Abdomen: Even when your purchase determination relies on the very best thought-through contrarian investing methods, it’s doubtless that within the aftermath of that call, momentum will proceed to push costs down, testing your religion. And not using a robust abdomen, you’ll capitulate, and whereas your determination might have been proper in the long run, your funding is not going to replicate that success.
As you’ll be able to see, the choice on whether or not to be a contrarian isn’t just one that you would be able to make based mostly upon the proof and principle, however will rely upon who you’re as an individual, and your make-up.
I’ve the posh of a very long time horizon and the luck of a robust abdomen, for each meals and market surprises. I’m not simply swayed by peer stress, however I’m not immune from it both. I do know that purchasing shares within the face of market promoting is not going to come simply, and that’s the reason that I initiated restrict buys on three firms that I’ve wished to have in my portfolio, BYD, the Chinese language electrical automobile maker, Mercado Libre, the Latin American on-line retail/fintech agency, and Palantir, an organization that I imagine is closest to delivering on thee promise of AI services. The restrict purchase kicked in on BYD on April 7, when it briefly dipped under $80, my restrict worth, and whereas Palantir and Mercado Libre have a technique to go earlier than they hit my worth limits, the disaster is younger and the order is nice till canceled!
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