(exerpt from The Only Three Questions That Count, Ken Fisher)

Friends Don’t Let Friends Be Contrarians

The media is generally wrong. Professionals are generally wrong or out to make a buck at your expense or both– and are at least fully discounted into pricing. Following the herd is fraught with peril. Does this mean you should do the exact opposite of what you hear from pundits and professionals? Should you become a classic contrarian?

Absolutely not. No, no, and no!

I am frequently called a contrarian. But I’m not– not as that term is generally used. Of course, I’ve been called far worse and will be, but the contrarian label happens to be wrong. Contrarianism has become increasingly popular in recent decades, rendering it priced by the market just as much as the concensus view. We are all contrarians now and none of us are. Being contrarian will get you about as far in the long term as being whilly influenced in your investment decisions by the New York Times and the nightly news.

The word contrarian implies going against the crowd– if folks are bullish, a classic contrarian beocmes bearish and vice versa. If everyone thinks electing a given politician as good for stocks, the contrarian sees it as bad. If everyone thinks bird flu will make stocks fall, the contrarian sees higher prices ahead. Technically a contrarian correctly knows what everyone assumes will happen won’t, but wrongly assumes the exact reverse will happen.

Let’s wade further into this. The market is a pretty efficient discounter of all known information so, as we stated multiple times, if people tend to agree something will happen to markets it won’t– something else will happen instead. But that doesn’t mean the something else that happens is the exact reverse. Suppose most folks agree the market will go up. That doesn’t mean it will go down. It might, but it might also go nowhere, which would also make everyone wrong. Or it might go up, but a lot more than anyone expects. That too would make everyone wrong. Over history, all those things have happened and in about equal proportions.

If you’re a classic contrarian and correctly see most folks agree the market will go up, so you bet it will go down, and then it goes up buy much more than most folks expected, you end up the most wrong guy in town. Being a contrarian is better than betting with the crowd, but not by much, and will still have you being right something on the shy side of one time in three.

Think of this like a 360 degree circle– like a compass. The concensus thinks the market will go North. Contrarians think it will go South. But it could just as well go East or West, making the crowd wrong and the contrarians wrong and the discounting mechanism work. Because those two other outcomes are less expected than the contrarian position, they actually happen more often.

The key is to remember– something else happens than what the concensus expects, but not necessarily the reverse. True contrarians these days aren’t much more right than concensus followers. It is surprise that shifts demand, which drives prices. The problem is the surprise could come from any direction.

Credits: This article is extracted from The Only Three Questions That Count by Ken Fisher, Wiley Finance, 2007.