Contrarian Approach to Day Trading
When hysteria rules the markets it is often profitable to follow a contrarian approach to day trading. Contrarians, in stock trading, look for and take advantage of temporary market inefficiency, as do many stock traders. However, the contrarian approach to day trading often lies on the opposite side of those who studiously engage in trend following in day trading. In a contrarian approach to day trading, traders seek to understand both the psychology of trading and the fundamentals that eventually determine stock prices.
If the stock market was totally and absolutely efficient only the fundamentals would drive stock prices. However, traders as well as long term investors look to gain advantage by predicting where stock prices will be in the future. When news hits the markets stock prices respond and often overshoot and then correct. When the news in confusing, there can be a great deal of price fluctuation. Long term investors think in months and years and day traders think in hours and minutes. Each looks to gain profit from market inefficiency. One of the best ways to profit from the news in day trading is to follow a contrarian approach.
Think of lemmings, those furry little critters that periodically run in herds over cliffs to fall into the sea. Then think of the dot com bubble some years ago, the volatile market preceding the 2008 market crash, and other times when herd mentality drove stock prices up beyond what was reasonable. The contrarian approach to day trading takes advantage of the “lemmings” that trade up stock prices in the absence of hard data or sell in panic without looking at the margin of safety of a stock. Profit for the contrarian lies in a firm grasp of fundamentals and a working knowledge of market psychology. Profitable day trading strategies commonly have to do with profiting from herd mentality.
The Fundamentals Rule, Eventually
Although technical analysis leads to short term profits, fundamentals eventually govern prices. It is in the reading of market sentiment about fundamentals and pricing that a contrarian approach to day trading can make money. A true contrarian picks his or her trades. He or she looks for overpriced or underpriced stocks to trade. In this way the contrarian approach to day trading resembles a value stock investor researching stocks and looking for a margin of safety and intrinsic stock value. When a contrarian has a clear view of where the stock price will eventually land he can look to where market inefficiency creates opportunity. The difference between value investing and a contrarian approach to day trading is the timeline. Day traders will want to close out their positions before the end of the trading day so their analysis deals with the shorter term.
and more ...