Behavioral Finance
By Christopher M. Uhl
“Buy when markets are fearful and sell when they’re greedy,” we all know the quote. The trouble is that “fearful” markets – when there are many more sellers than buyers driving prices lower as investors flee – are by definition lacking buyers to support valuations. It is natural for people to capitulate to the crowd, and likewise very difficult to oppose the overwhelming majority, especially in the face of falling prices in real time, where the sellers appear to be right. But this contrarianism is exactly what is required in order to “buy low and sell high.”
To make matters more challenging, constant contrarianism has proven extremely detrimental to financial health. Consider being short the SPY (or some other broad index) and long the VIX (volatility index) over any considerable period of time: There may be brief instances when this yields a gargantuan payday like during the financial crisis of 2008, but generally this would be a painful position to hold.
The key to effective, selective contrarianism is to recognize opportunities where the majority have devolved into states of fearful panic or greedy euphoria, differentiating those from situations where there is reasonable justification and proportional changes to an asset’s value (even if you disagree with the change). This is orders of magnitude easier said than done. For a deeper dive, Adrian Iliopoulos leads a fascinating dissection of contrarianism in this article.
