Magazine article Modern Trader

The Triumph of Contrarian Investing

Magazine article Modern Trader

The Triumph of Contrarian Investing

Article excerpt

The Triumph of Contrarian Investing By Ned Davis McGraw-Hill New York (2004) $21.95, 177 pages

A respected and well-known market historian, Ned Davis has spent decades studying, refining and using market measurements and indicators to determine levels of bullishness or bearishness. This book specifically focuses on the rationale and history of using contrary investing principles based on crowd psychology.

The premise of the book is that crowd behavior is either too bullish near market peaks or too bearish near market bottoms. At those extremes, smart investors can make money by going against the crowd.

So-called stock market experts have not been able to forecast the stock market's direction reliably one year in advance, as attested to by the dismal record of these strategists during the bear market of 2000-02. Ninety-five percent of them were wrong on the market's direction, let alone its one-year forward performance. That is where contrary investing works. When the majority of gurus are so heavily weighted in one direction, then it could pay to go the other way. In general, one caveat with market strategists is that they are bullish most of the time, so using them as a contrary indicator will only work sometimes. There is a better approach.

More specifically, Davis in his new book, carefully lays out the case for "contrarian" investing. By that terminology he means patiently waiting for extreme market conditions, as measured by specific market indicators, to signal entries or exits. Exiting the market could mean going into cash, alternative investment vehicles or even going short the market.

Davis illustrates a handful of ways an investor can determine extreme market bullishness or bearishness so that an opposite position can be taken to consistently profit from the expected change in market direction. …

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