How to Strike It Rich Looking Like a Genius: 8 Rules for Contrarian Investing

Master these eight rules and improve your contrarian trading experience
By Sol Palha ,

Contrarian investing is all about overcoming emotions such as fear and euphoria. You should rule your emotions instead of allowing them to rule you. Otherwise, losses are all you will have to look forward to.

Contrarian investors act counter to prevailing trends. This takes a sound understanding of trading and investing, and a cool head. It's easy to follow the herd when it comes to investing. That's because it seems safer. But successful contrarian investors have the potential to do better than others. They are able to take advantage of opportunities that others miss. 

Below you'll find eight eight rules that can help you become a successful contrarian investor. They involve are based on common sense and the ability to think in advance. 

1. Patience and Discipline

If you fail here, all other rules are useless. Trades do not always appear quickly. Investors often have to wait for the right moment. Smart investors may have to wait for the market or a stock to come to them. And it's best if investor sentiment is euphoric or in panic mode. That may give a contrarian investor a clear signal to go in the opposite direction.

2. Popular Media

Understanding the psychology of the masses can help make you a better investor. Investors should use popular media outlets to generate contrarian ideas. They can help you determine what the masses are frothing about and what investments you should pick or  avoid.

3. Formulate a Plan

The plan should include profit targets on every trade, and, an exit plan, in case the trade does not work out. Decide first how much you are willing to lose. Do not only focus on how much you want to make because some trades will not work out. If the trade sours, the stop you have in place will limit your downside. Ensure the stop is a trailing stop. That is, the stop will automatically adjust as the stock rises in value. Your chances of walking away with a profit will be much higher. Never widen the stop. If the stock still looks good, wait for conditions to calm and reassess the situation. By the same token, take some money off the table when profits start to roll in. You do not have to close the entire position, but it's always a good idea to take some profits in the beginning. If the stock suddenly takes a turn for the worse, you still earn a partial profit.

4. Options Are a Big No-No

Under no circumstances should you jump into options if you have just started trading, except for selling covered calls, or puts if you understand the strategy. First try to make some money buying and selling stocks. When you become good at this, you can venture into options. If you are buying calls and puts, wait until you have banked some profits and only use profits to speculate.

5. Money Management

This point cannot be emphasized enough: No matter how good a trader you think you are, without proper money management your chances of success are slim. The most important rule is to spread out investments. You'll be covered if something goes wrong. Too many traders become emotional and suddenly feel that they have discovered the home run stock. Instead of a home run, they may strike out. It's best never to count too heavily on any one investment.

6. Technical Analysis

Whether you choose to become a contrarian investor or not, you can greatly improve your trading results by understanding the basic concepts of technical analysis. Getting a grasp of the following, support points, resistance points, ADX, simple moving averages, relative strength index and understanding the concept of drawing simple trend lines, can only make you a better contrarian investor.

7. Understand the Market/Sector You Are Entering

Do not jump into the markets without taking the time to understand the sector you are getting into, unless you have opted to play the indices. If you are going to be an index trader, then get a feel for the markets. There is a wide chasm that separates theory from practice. Here is an extensive of free sources. 

8. Learn to Relax

If you are not relaxed, your emotions will take over to your detriment. Contrarian investing is all about dealing with emotions. If you are stressed out, you are starting off wrong. How will you be able to spot any change in emotions if you are already emotional? Whenever you feel that the situation is getting to you, take time to regain your perspective. There is a time to be long, a time to be short and a time to sit out. Sit on the sidelines when you are emotionally unstable or stressed.

Final Points:

The best time to open a contrarian position is when most investors are feeling intense happiness or distress. Such extremes in emotion create opportunities. 

You'll know you are doing something right when you feel nervous about opening a position. A true contrarian is always nervous before he opens a new position. If you are feeling too confident, reassess the situation. Perhaps you missed something.

It's normal to feel nervous when you are going against the crowd.

This article was prepared by Sol Palha senior analyst at the Tactical Investor an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.  

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