Where Angels fear to tread

23/07/2017 | By | Reply More

One thing I’ve learnt over time is that whether it’s short term trading on Betfair or long term investing in financial markets being a contrarian seems to be a very, very effective strategy.

Why does contrarian behaviour work?

Over the years I’ve spent a lot of time looking at psychology and its impact on decision-making and it’s proved a fascinating subject. I’ve immersed myself in as much material as I can find, all in the quest of really trying to understand how people make decisions.

It’s a complex subject, but to be short, being contrarian works because people tend to look to others to validate their decision. This tends to be in the context of a social circle but in trading, it’s often the market.

FOMO factor

It’s the FOMO factor. If a market moves, people fear missing out so jump on board. OK, it could go wrong but then at least they won’t look foolish, as everybody else is doing it. When the market turns everybody thinks they can get out before others but that often sets off a wave of selling and things go into reverse.

You can witness this in financial markets regularly and on Betfair daily.

It also happens in reverse. Something is deeply unloved and you would look a fool for saying you like it. Whether it’s a team, a commodity, a horse. Things are so bad that saying you like it or are going to buy, or back, it will make you look a fool. Especially if it doesn’t bear fruit. The crowd want you to comply to be like them and if you dare go against them then expect to feel their wrath, especially if you fail. That is why is so hard to be contrarian, no matter the logic.

It all dates back to how we were built and evolved. There is an evolutionary need and desire to be accepted by a group, that’s how we succeeded and got to where we are. Unfortunately, our lifestyles have evolved much faster than the brain in which we navigate it. So that is where there is a disconnect.

Learning to be unpopular

I see these patterns recurring ALL the time in many different markets. I can’t stress enough how many biases you see when you realise this. But of course just being contrarian just isn’t good enough to turn a profit, why?

Imagine you see a crowd running in one direction, they could actually be running from a threat. So just being a contrarian could lead you into a trap. The best way of avoiding a trap is to research, prepare and wait for an opportunity. You are under no obligation to take an opportunity, so wait for one that you are sure about.

A couple of contrarian trades

On Betfair markets, I’ve often posted videos of me catching a bounce or going against the prevailing trend. I’ll only do this when I see activity has dried up in one direction. If something is heavily backed but is no longer being backed then it merits a trade.

Sports markets have a tendency to revert to mean as all prices are related. So if something is backed heavily is can’t go on forever as value is created on other runners encouraging backing there. If other runners are backed then it’s unlikely the favourite will continue to be backed. There can often be other factors as well, see a video I recently released: –

But the ability to act in a contrarian manner really arrived to me via financial markets. It’s the core of a value investing strategy. The stock market tends to overreact in either direction on a frequent basis.

Most of my research for investing is done quite casually and I read up on companies, industries and the like on a constant basis to drum up ideas and things I could be interested in. When I locate an interesting business I value it and then make a decision from there. If the value is much higher than I deem sensible, I pass but keep it on the list and keep reading up on it and the industry. Now and again the market present and opportunity to buy it at the right price.

A long time ago I was an IG Group shareholder when the came to the market. I eventually sold but kept tracks on the business and got to know it inside out. I was also interested in it from a general perspective as it is aligned, indirectly, to what we do at Bet Angel.

In late December last year, the regulatory bodies announced, unexpectedly, a wide ranging review of the marketplace in which they operate. It was greeted by a collapse in their share price as the market panicked about the implications. In September it was nearly 950p, the day of the announcement it closed at 485p. So I started buying.

I had done my work on the stock a long time ago and knew all the dynamics pretty well so it was just a case of factoring in the news and seeing if I had a reasonable price. On the basis on which I measured it, I had a great price.

There is an important lesson that follows. Despite my confidence, the price dipped as low as £4.50 in the next few weeks before starting to recover. I hadn’t forgotten the one that got away from me many years before. I bought into a company at $15, it felt to $12.50 so I bailed. Less than a decade later it was over $150. This is why you see me hold positions for much longer. You can guess the longer term result well, but maybe not the short term movements. So I buy in chunks to average out my entry price. I’d rather be roughly right with my timing than miss an opportunity by trying to be perfect.

For IG Group I was just looking for a return to a reasonable value and sat and waited for progress reports for how the regulation had actually affected them rather than speculating on how it would. When the FY17 results were announced this week the market finally caught up with my judgement and leapt 16% on the day. It’s been the largest ever position I’ve taken like this but is still tiny compared to the market cap of over £2bn. If you are interested in what I’ll do more of in the future, it’s this sort of thing because it’s so scalable.

As the position climbs higher I’ll reduce my holding. How contrarian of me! Going against the crowd can work, if you use it correctly and works because of the primitive instinct people feel. If you can step outside of that, you will often be unpopular but find yourself in a good place.

 

 

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Category: Trading strategies

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