The folly of trying to be clever

I've been meaning to write this post for a while. I tend to approach the markets from a contrarian perspective. I try to be mindful of what others are doing and avoid or do the opposite of a trade that  becomes too popular. I don't like the thought of possibly being late to a crowded party and then be left holding the bag with the rest of the lemmings. I much  rather prefer trying to be one step ahead of everyone, arriving early to the next party. There's a certain satisfaction one gets using a contrarian approach. It makes you feel clever avoiding groupthink and doing what most others aren't and if you get it right it can be very lucrative.  On a personal level, I'm very much a contrarian. For instance, unlike most of my friends, I didn't let myself go. I'll be 44 this year and without trying to sound arrogant, I don't look or feel like a 44 year old. When new people I meet first realize my age I almost always get a surprised look on their face. I workout everyday for 45-60 minutes and I eat fairly clean.  I can still keep up with 20 somethings on the soccer pitch.  I do what most people my age don't do and I take pride in that. 

There is however pitfalls with contrarian thinking when it comes to financial markets. In order to be successful at taking a contrary approach you need to be mindful that there will be a period of time when the crowd is "right" and if you fail to appreciate that, your contrarian stance will prove too hasty which could lead to leaving big money on the table or even worse taking heavy losses betting against the crowd. It can be difficult to know just how far the crowded trade can go on for. You might think that everyone is all in only for there to be a new group of "suckers" that come to the party.. The other pitfall of contrarian thinking is being a contrarian just for contrarian sake. For example, taking a contrarian stance that grass will soon be non-green because everyone believes it's green is foolish. In financial markets a good example is when a company files for Ch 11 and the stock crashes since  it becomes fundamentally worthless. Taking a contrarian stance on such an outcome will prove futile aside from the temporary stupidity/ignorance that could happen like with Hertz stock in June. 

Then  there's also the possibility that you could be flat out wrong about a contrarian call whereby you think you're being a contrarian when in fact your thesis is being shared by many others too which therefore makes YOU the sucker. I think we've been seeing this type of phenomenon play out more so in recent times. The 2000-2002 and 2007-2009  big bear markets created a legion of bitter, cynical investors who vowed never to be a "sucker" again. I often call these folks the permabear trading community. After getting burned by bear markets they vowed never to be fooled again by "Wallstreet crooks" and blogs like zerohedge became popular.  The COVID crash may have added a bit more to this ilk but at the same time it minted a legion of newbie millennial traders. The perrmabear trading community scoffed at these millennials saying "just you wait and see, they're gong to learn a hard lesson!". The ironic thing is that the permabears you see today were once like the naïve, happy go lucky newbie millennial trader until they eventually turned to the dark side after getting burned. So what I suspect ending up happening is that many of the permabear trading community bet against the highflying stocks like TSLA thinking they are being clever contrarians and ended up just adding fuel to the fire making the so called "contrarian trade" not so contrarian after all.  So long as there's a greater fool, there's no limit as to how high or how long a stock/asset can go. Bearish bets placed against an asset are a potential source of buying power especially when being placed by weak holders like those of the permabear trading community tend to be. Eventually we'll get to the point where most of the permabear types will throw their hands up in the air and say "if you can't beat em, join em" or at the very least step aside. But this transition could take time. You might see the permabears back off for a while but on the first hint of notable weakness they come back, much like a crack addict who quits and then uses again a few weeks later. We saw this happen in the aftermath of 2008 crash.  

So in conclusion, be careful trying to play the contrarian for you may be early or not actually be one after all. If you are going to make a contrarian bet you need to make yourself a strong holder. Making a large bet with a "tight stop" is an example of what not to do. Come in with the expectation that you probably going to be early. If you're going to go long be prepared to handle ANY amount of paper loss which means you position your size accordingly. If you want to make a bet against a stock, I strongly advise to use (if possible) long dated  put options,  this way you can't be forced to cover if the position goes against you and you're giving yourself plenty of time for your thesis to pay off.  Don't buy options that will expire in a couple of months. Again, come in with the expectation that you will be early. 

Next post I will talk about bitcoin which was also a long time coming.