Stock Market Worsens – Adopt Contrarian Strategy

Now is the time to be a contrarian investor before it’s too late. Today’s selloff broke the 200-day moving average barrier (a popular longer-term trend line). Moreover, this is the third downside rollover, a highly negative indicator. Below is the updated graph from this article:

So, what to do? Be bearish, and that means being a full-fledged contrarian. Ignore any positive media articles because the now-obvious stock market decline could quickly darken the mood and outlooks.

Note: For more explanation of the adverse issues and conditions, see this article and the ones linked therein…

When the negative shift occurs (it could be soon), expect four emotionally-charged stages:

1. Disturbing selloff (this has started)
2. Distressing plummet
3. Unnerving bottom
4. Distrusted reversal

So, what to do? Here is the contrarian strategy for investing success during such a period:

First, the selloff

Build substantial cash reserves prior to the plummet, and begin to put together a list of desirable companies and/or funds that were not the favorite leaders in the previous bull market. (Lightening rarely strikes again in a new bull market. So, forget about dead-cat bounces, and focus on attractive, longer-term investments.)

Second, the plummet

Read the media reports (not just the headlines), track investor attitude measures, watch the stock market’s behavior, and track individual stock charts (this is when technical indicators are especially useful). The goal is to identify the time that negativity becomes pervasive and the outlooks become dire.

Third, the bottom

This is the “fun time” when the identified stocks and funds reach technical low points and become attractive buying opportunities. However, be forewarned: This is also when being a contrarian is the hardest – for all investors, even the most experienced professionals. A long-time successful trader provided an apt description: “The bottom is when you hear the words, ‘stock market,’ and you want to throw up.” Therefore, a sound strategy is to commit only a portion of the cash reserves to new stock market positions. While 100% invested provides the greatest upside return possibility, there is never a 100% probability that the stock market is truly at the bottom. And without some remaining cash reserves, negative emotions will grow along with losses.

Fourth, the reversal

Now, for contrarian investors, this really is the fun time. It’s when there is confirmation that the bottom is likely over. The reversal is usually rapid as cash-rich buyers rush to capture the still-low prices. Naturally, that produces good gains in the new holdings acquired at the bottom.

The contrarian stance then becomes easier

At the bottom, the media and many investors become convinced that the dismal fundamentals and the low prices foreshadow worse conditions to come. Therefore, the puzzling fast reversal is explained as a dead-cat bounce, meaning they presume it is an opportunity to sell and even go short or buy puts.

However, for contrarian investors, the new gains are the proof that, yes, that was the bottom. Therefore, more buying can be done because most likely the next bull market has just begun.

The bottom line: “Buy low” is easy to understand, but hard to do

There is no way around it. Stock prices don’t hit attractive levels when investors feel good. It takes worry to produce buying dips. And it takes fear to produce buying bargains. Therefore, the acid test is whether you feel good and confident, or you feel worried and hesitant. Obviously, those latter feelings are the contrarian proof that the time is right to buy.