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A contrarian investor is one who believes in going against the conventional wisdom of investing for makingprofits from an investment. Contrarian investing revolves around the concept that crowd behavior among investors could lead towrong and exploitable pricing in the securities markets.

The main hypothesis of contrarian investing is that widespread pessimism surrounding a particular stock could drive the shareprice so low that the companys risks become overstated and prospects understated. Similarly, widespread optimism may result inover valuations, resulting in an eventual decline in the share price.

One of the notable contrarian investors is Warren Buffett, who believes in buying a stock when its price is beaten down by theshortsightedness of the market. David Dreman, John Neff and Mark Ripple are other famous contrarians.

The strategy of a contrarian investor is related to behavioral finance. Studies in behavioral finance have demonstrated that investors as a group tend to overweight recent trends while predicting the future.

How Does a Contrarian Investor Trade?

The trading principles of a contrarian investor apply to individual stocks, the industry, the sector or any other asset class. It could as well be applied to the entire market. A contrarian buys or sells stocks when most investors appear to be doing theopposite. They do it only to that extent that the stock is not fairly priced. Contrarian investing is mostly resorted to in situations when the entire market is either rising or falling. Volatility indexes are the most commonly used indicators by contrarians.

Contrarian investing requires an investor to value a stock fairly accurately. Such investors study the financial health of a company in great detail, while also using matrices like the book value or P/E ratio to determine whether a stock is under-priced. A contrarian investor works in a manner similar to a value investor.

Benefits of Being a Contrarian Investor

A contrarian investor reduces his risks by not investing in an over-hyped market when such a scenario goes against theexpectations of the crowd. Such techniques have proved fruitful in both bullish and bearish markets.

Risk of Being a Contrarian Investor

If the decision is always taken against the crowd, it could lead to lost opportunities to make profits.