The Art of Contrarian Investing: Perceptions of Markets Vs Markets in and of Themselves
For me, the art of contrarian investing is a philosophical one. The words of Henry George come to mind:
Unless there be correct thought, there cannot be correct action, and when there is correct thought, right action will follow.
In the terms used by Ludwig von Mises in Human Action we might say the following; unless there is correct identification of suitable means for an end, that end cannot be correctly attained. When suitable means are identified, correct utilisation of those means for the end may take place. So, if we seek consistent profits via financial speculation, then we should think very carefully about the intellectual resources that we use.
Here, I discuss the common pitfalls in the consensual investor’s market philosophy, and the virtues of contrarian investing.
The Tendency for Investors to Skip the Essentials:
I cannot help but suspect that – usually – very little effort goes into understanding the nature of markets, and a lot of effort goes into conducting the research and analysis that immediately precedes execution decisions. For example, I doubt that many traders/investors seriously consider the following questions:
- How do I perceive the nature of markets?
- How do others perceive the nature of markets?
- How do such perceptions differ from the market’s true nature? How can I understand?
- What knowledge/understanding should precede execution decisions? How is my answer justified?
Without a serious and thorough investigation of the above questions, can you see how the typical investor’s actions might be somewhat sporadic in nature? Further, can you see how the great, consistently successful speculators of the past 100 years might take on a mystical character?
A Manifestation of the Lack of Rudimentary Thought: the Fetish for Information
Now, I could be wrong, but I strongly suspect that the typical investor takes on a ‘default’ market philosophy. The nature of the markets is deemed to be a given – so to speak. Thus, we often hear dogmatic statements such as ‘markets have done such and such because of such and such’, or – even more dangerously – ‘markets should do such and such because of such and such’.
A corollary of this mechanistic characterization of the market is that a fetish for information arises. My hunch is that the consensual investor thinks; ‘if only I can get the most information the quickest, then I’ll profit’. Going further, perhaps people also believe that the only way that anyone else succeeds is by having such an ‘informational advantage’. Thus, in our age, we witness the folly of enshrining the black-box, the HFT algorithm and certain hedge funds. Resultantly, the quantative, black-box, HFT-focussed hedge fund becomes the ideal. In tandem, the information industry around the financial markets grows ever larger.
The Premises behind the Information Fetish:
The underlying assumption is that – with such information – one will be able to tell ‘what the market will do’ before it does it. Whatever that ‘what the market will do‘ is, contains a whole host of prejudices that are not necessarily justified. That is, they do not necessarily align with the true nature of markets. The point is that, regardless of whether a person or a computer executes, there is some kind of human premise behind each trade. There’s always some kind of intellectual conviction about the way the markets ‘should‘ work.
Perceptions of Markets Vs Markets in and of themselves:
Space and time are two inescapable forms of our perception. We are always in some place at some time, and we cannot conceive of otherwise – indeed, anything other than perception in space and time is not a discussable topic. As each of us must (at least) uniquely occupy components of space and time, we all must perceive the world in a different way. Further, as the lens with which we view reality is shaped by our former selves (which are uniquely composed), we can say that each of us brings a different view to the table. Jason Alan Jankovsky’s description of his own realization (in The Art of the Trade: What I Learned (and Lost) Trading the Chicago Futures Markets) is particularly lucid:
Up to this point, my concept of reality was based on a set of personal experiences. Since everyone’s experiences are different, then it follows that everyone’s concept of reality also must differ. This hit me like a ton of bricks. Until that point I really believed that “reality” was basically the same for everyone. What would lead anyone to accept this? For starters, have you ever stopped to think that you surround yourself with people who basically agree with you and your train of thinking?
With regards to markets, this means that each of us has a unique take. The essence of being successful in financial speculation, is to have a view of markets that reconciles with the true nature of markets (whatever that may be). Again, quoting Jankovsky:
Market reality only functions one way, but we bring a personal definition to the table when we trade. We are trying to make sense of what we perceive, and the only basis we have to do that with is our previous world and life view, perspectives and belief structures. The end result is that we as traders “see” the market differently than everyone else, but the market itself is only functioning one way and will never be any other way. So the true state of trading reality is in conflict with what we personally think it is. We can choose to define it any way we want. It’s the definition that creates our gains or losses.
Contrarianism: A way to align oneself with the true nature of the market
Due to the zero-sum nature of financial markets, we know that not all people can be well-aligned with their nature. That is, some people ‘win’ and others ‘lose’ – it has to be that way. Further, it is an empirical fact that the vast majority of investors and traders are unsuccessful. As Robert Prechter wrote in The Wave Principle of Human Social Behavior
There is a myth, held by nearly all people outside of back-office employees of brokerage firms and the IRS, that many people do well in financial speculation. Actually, almost everyone loses at the game eventually. The head of a futures brokerage firm once confided to me that never in the firm’s history had customers in the aggregate had a winning year.
So, given these facts, how can we ensure that we are aligned with the true nature of the market?
Contrarian investing is a means by which to align ourselves in such a way. By doing precisely the opposite of someone with a perception that’s antagonistic to truth, one can personally succeed. Jankovsky (in The Art of the Trade: What I Learned (and Lost) Trading the Chicago Futures Markets) provides us with some further insight:
Since the loser is absolutely convinced he can make a loser out of someone else… and every other loser is thinking the same thing, it follows that the winner must be thinking something entirely different in order to take their money with consistency.
An Endeavour of Intelligent Guesswork?
We should note that each person’s mind is an island. A person ‘A’ has no direct access to the mind of person ‘B’. So, the key question, is; how can we know? The answer is that we can’t – rather, it is a game of intelligent guesswork. In particular, when people – as a whole – seem to think in a specific way about the future course of prices, then it is typically wise to take the other side. There is no guarantee that one is being contrarian. Rather, it is only likely that one is.
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