2010-03-19: Contrary opinion
Although prices can surge or plunge out of proportion to the reality of fundamentals, ultimately, realities take hold, eventually returning prices to their proper levels. In the interim, however, emotion and psychology of the mob is to understand the psychology of the speculator. Understand how to use these psychologies to your advantage, and you’ll understand the art of contrary thinking.

“The law of an organized or psychological crowd is mental unity. The individuals composing the crowd lose their conscious personality under the influence of emotion and are ready to act as one, directed by the low crowd intelligence.” - Thomas Templeton Hoyle

At the start of a trend, a few far-seeing individuals anticipate an alternative scenario to that being promoted by the majority. Later, as prices rise, others are persuaded that the scenario is valid. Then, as the trend extends, more people join the camp, perhaps being persuaded as much by the rising prices as the concept itself. Eventually the concept or premise becomes a dogma with everyone accepting it as a gospel. However, by now, it has been so well discounted or factored into the price that the security in question is way overvalued, the concept begins to lose its original premise and a new scenario emerges. All those betting on the old idea then lose money as the price reverses to the downside.

The theory of contrary opinion was formed by Humphrey Neil, Mackay, Le Bon and Tarde. Today it is widely understood that since the crowd is wrong at major market turning points, the only game in town is to be a contrarian! Unfortunately, whenever a concept or theory becomes popular, the basic idea is often distorted. Neil pointed out that the crowd is actually correct for substantial amounts of time. It is at turning points that the majority get things wrong. It is this idea that is really central to Neil’s thinking.

Contrary thinking is the art of thinking and interpreting reality in a different way from how the majority of individuals think and interpret reality. Contrary thinkers expect higher prices while most people expect lower prices and then watch for prices to fall when most people watch for prices to rise. Contrary thinking is not necessarily a measure of stubbornness, but rather the ability to avoid being caught up in the sentiment of the crowd.

Some people are swayed by the direction of a major trend and moreover, they are strongly influenced by the opinion of others. Therefore, market movement in a particular direction, if strong enough and long enough, tends to arouse public interest. Traders and investors develop tunnel vision.

The important facts, the ones that will lead to an eventual change in trend, are often ignored. Even when the markets begin to change direction, those who have been fascinated into eagerly believing that the trend has not ended will continue to cling desperately to their beliefs. In the meantime, the contrary thinker has suspected all along that the direction of the trend was due to change and that the opportunity for profit lay just around the corner.

To act and think contrary to the crowd is a valuable quality in every walk of life. It is important that the contrary thoughts and actions be selective, however. It is also important that contrarian thinking be employed at crucial turning points in our lives and in the markets.

Followers of contrary opinion have great potential in the markets, but good timing must back them up. Be certain to use effective tools. Contrary opinion is an important skill that allows you to develop an opinion that is often opposite of the view held by the majority of market participants.

Despite the many investment fads and financial fallacies in recent times, many investors and traders have not yet learned anything about their own emotional makeup.
A good contrarian should not go contrary for the sake of going contrary, but should learn to think in reverse, to creatively come up with alternative scenarios to those of the crowd. In other words, try to figure out why the crowd may be wrong. By using technical indicators it makes it easier to take an opposite view from the crowd as you remove feelings from trading.