A countertrend strategy is a method of investing where the investor goes against the current market trends in order to capitalize on mainstream investors. When other investors are primarily selling, a countertrend investor will buy, and when others are buying, he will sell. This takes advantage of dips and ebbs in the marketplace, but really makes profit when the market has a drastic rise or fall. The methods used to determine the profitability of a countertrend strategy are typically very complex; one wrong move, and the investor is left with a lot of worthless investments.
The old investment adage of ‘buy low, sell high’ is used much less often than one would think. For many investors, going with the flow of the market and riding out variations is much more common than responding directly to the market. In addition, investors have a tendency to go with the majority trend, which often amounts to ‘buy high, sell low.’
Countertrend investors use the opposite approach. When the market dips and the price of investments drop, they buy in at a rate much lower than average. When they make their investments, the market is often in a bad situation and there are typically many more sellers than buyers. As a result, a countertrend strategy allows investors to spend less and gain more than typical investing.
When the market picks back up, the countertrend strategy tells investors to sell. In this case, there are more investors interested in buying back into the market to capitalize on its success. This usually results in more buyers than sellers and allows for huge profits for the countertrend investor. These investors will make money even when selling an investment for an average market price since they purchased when it was so low.
At first glance, a countertrend strategy seems like a foolproof way to make money. There are two main factors that make some investors steer clear of these methods. The first is a lack or flexibility in the overall portfolio. A true countertrend investor only has investments when the market is down. When the market is healthy, they don’t have any short-term investments paying in dividends.
The second detraction to countertrend strategy is its dependence on market recovery. If the strategist invests heavily in a specific market, he can only hope that market will recover its previous value. If the market ends up stabilizing at a much lower rate, or if the dip causes an invested company to fail, the investor is left with investments that nobody wants or ones that are totally worthless.