Mass Psychology Vs. Contrarian Investing

By: Sol Palha | Thu, Feb 24, 2005
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"The best cure for hypochondria is to forget about your own body and get interested in someone else's." - Goodman Ace, American Author, Radio Personality

Contrarians simply take a position that is contrary to the masses and that about wraps up the ideology of being a contrarian. However investors who use mass psychology look at other things. Mass psychology applies the principle of contrarian investing but it does not stop there it goes several steps further. Let's look at the Commodities market for example

The commodities market has several components to it, two of them being the Gold and Silver sectors. Now throughout 2002 and early 2003, the hate and disgust for both these sectors was extremely high. Fast forward to 2004 and Gold was being mentioned everywhere; even CNBC had a little ticker that stated what the price of Gold was throughout the day. The hate or disgust for both these sectors were no longer there and even though both these sectors have a long way to go before they are fully embraced they did not provide a psychological basis for taking new positions in 2004(key word being taking new positions). Right now the sentiment is slowly changing and the time for taking new positions may soon be at hand. In fact one should spend time studying the charts of various stocks looking for the strongest ones and then using simple trend analysis to determine entry points.

Even though the masses have still not embrace Gold yet, this concept does not really matter in the long run. A more important criterion would be to find out what % of investors has taken positions in these sectors or not. Next one would try to find out what the individuals that are bullish on this sector are doing. If all the Gold bugs are bullish then based on the contrarian rules of investing you should take a contrary to neutral position because all the individuals in your group are now bullish. Another big problem is who cares if the masses are negative, since the masses in general are most likely never going to take a position in this sector to begin with; if they do it will be close to the end of the Bull Run. In the last Gold bull, the majority did not even know what was going on, let alone take a position in this sector. So one measure would be to determine if all the people who believe in Gold have already taken positions, if they have then the market has become saturated. The only way it can continue to go up is because momentum players have come on board; however once they decide to bail out the corrective phase could be very painful. All we have to do is look at the Internet era to remember what can happen once these chaps bail out.

So mass psychology is the constant analysis of the playing field to determine how the game is being played. One has to take measures at different levels and then do a comparison and this is where it blows contrarian investing away. Contrarians take no measures against themselves, they only measure their position against the crowd and therefore they can get smashed to pieces at times. The Internet boom lasted one year longer after all the TA and contrarian indicators were in the extremely bearish zones. Euphoria for this sector was running sky high and if one had simply used contrarian indicators and shorted the market one would have been blown out of the water into the frying pan and roasted alive.

Mass psychology involves work, while contrarian investing involves almost none other than simply jumping from one side to the other side. Therefore most pure contrarians were caught flat-footed when the Equity markets mounted this huge rally from Oct 2004. Their contrarian indicators suggested that taking short or neutral position was the right thing to do.

No matter what people do, only 10% of the investors can win at any given time. The moment more start wining no matter what side of the fence they are on contrarian or on the masses side; the markets will adjust to bring this ratio back to its norm.

We will give you another example of contrarian investing VS psychological investing. While all the contrarians were pounding the table on Gold from DEC 2003 to the present day, hardly anyone noticed the oil sector. If you go back and look at the stocks in both sectors you will see that the Stocks in the oil and oil related sectors blasted the Gold stocks into the dust in terms of percentage gains over that period (yes just like any sector we had some dogs to). This is a very big topic and we could go on forever but the morale of the story is that basically you have to monitor other individual's behaviours constantly. This entails monitoring the behaviours of other contrarians and then taking opposing positions to them. To make sure you are indeed doing the right thing, you can perform a simple trend analysis on the sectors you think are the right ones. If a new up trend is in place and the contrarians are negative on it and or the masses, ignore them both and go long.

So investing based on psychology actually amounts to not only taking a position against the masses but against the actual contrarians themselves once their euphoria has reached extreme levels, or at the very least taking a neutral position.

Slowly by slowly less attention is being paid to the Gold and Silver sectors and both are becoming good investments from a contrarian and a Mass Psychology perspective. The stocks have been hammered and we just have very little more to go before a new buy signal will be flashed. We now just sitting and waiting for that buy signal to be flashed before taking new additional positions (one should have core position in Gold and or Silver bullion at all times). Interestingly some Gold stocks have already started exhibiting signs of strength and flashing some minor positive divergence signals.

"Minds that are ill at ease are agitated by both hope and fear." - Ovid BC 43-18 AD, Roman Poet


Sol Palha

Author: Sol Palha

Sol Palha

Sol Palha is a market analyst and educator who uses Mass Psychology, Technical Analysis and Esoteric Cycles to keep you on the right side of the market. He and his partners are on the web at

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