When to Be a Contrarian

07/08/2014 6:00 am EST


Gregory Harmon, CMT

Founder and President, Dragonfly Capital Management

These days, when in comes to the markets, it’s become quite popular to take a contrarian stance, but Greg Harmon of Dragonfly Capital, makes the case for why it doesn’t make sense to be a contrarian unless you are incredibly lucky.

There are times in life when it pays to be a contrarian. If you are at a religious cult event and offered some Kool Aid. If you are a part of a stampeding herd toward a cliff. After having a few beers at the ballgame your work group decides to streak across the field. Even without hindsight in these situations it makes sense to go against the crowd. But what about in the stock market?

Actually, it is quite popular to be seen as a contrarian in the markets. Popular, but it really does not make any sense to be one except, maybe, in extreme situations. Most vocal contrarians talk about the broad market. This is probably the best example of where you are most likely to be wrong as a contrarian. Betting against the whole market is like a salmon trying to swim up Niagara Falls to spawn. A trend can continue longer than 99.99% of people can predict. And it is very hard to figure out where the end lies. So the ‘successful’ contrarians are often the ones that just got lucky at calling it. The last one standing.

Companies gather all sorts of sentiment data and review hundreds of derived indicators looking for a correlation to the end of the last trend. They will find one, with a strong correlation, but that does not mean it will work again, or at the same time. If it works you will win. But if it does not then you lose. Money. Dollar bills. Either your own or your clients. This is what is so hard about being a contrarian. Especially in the broad market. How do you decide that what has been working will no longer work? Waiting for confirmation of a reversal does not win you any prizes for that big prediction. But it does allow you to keep your money invested until the data say it is time to get out.

This is the biggest point that those with a countertrend view espouse: Why take the risk for the last few %, when a reversal is imminent from the data. I block people that talk like this. There are so many things wrong with that view. How do you know that the upside is limited? Many have been calling for a stock market correction since November 2012. Where has that gotten you? The S&P 500 (SPX) is up over 45% since then. I did not know it would keep going that far. Did you? Many are calling for cash positions and looking to short again now. What if the S&P goes from the current 1975 level to 2300? Anticipating a turn is a fool’s game. You can be prepared and when the market turns act quickly just as easily.

So when does it pay to be a contrarian? At extremes, when the direction is already starting to turn. And even then you will be wrong often. I don’t recommend it. This is really just a lesser degree of safety in waiting for confirmation of a trend change. So, why do you want to be a contrarian? If you are in the market to make money for yourself or clients it makes no sense. If you are trying to make a name for yourself, you may be successful…Once. Put it to good use. It will have to last you a lifetime. What side are you going to be on in this issue?

By Greg Harmon of Dragonfly Capital

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