Being a contrarian in trading is not enough

BEING A CONTRARIAN IS NOT ENOUGH

In trading you
generally hear that to make money you have to be a contrarian. This
is a half-truth. You need to be an independent thinker. You shouldn’t be a
contrarian just for the sake of it.

There’s a famous
saying “60 million Frenchmen can’t be wrong”. This is based on the idea that
the crowd is collectively smarter than any one individual. Therefore, you can
follow the herd (the trend) as long as there are reasons to do so, but you need
to look out for signals that can change the picture and reverse the trend.
That’s the contrarian part.

Soros once said
that he was considered a contrarian. He added though that he was very cautious
about going against the herd and most of the time he followed the trend. All
the time, he was aware of being part of the herd and he was always on the
lookout for inflection points.

When the reasons
to follow the trend start to weaken and you begin to see signs of a change,
that’s when you can build a contrarian thesis. Your thesis might not come to
fruition though without a catalyst. You generally need something to trigger
your view and get the market to follow it.

The markets can
overextend beyond the fundamentals which is why Keynes once said that the
market can remain irrational longer than you can stay solvent.

EXAMPLES OF CONTRARIAN THESES AND CATALYSTS

The most recent
example is the dovish Fed pivot in December 2023. The market at one point
expected seven rate cuts in 2024. The contrarian view was that the Fed’s pivot
would reignite animal spirits and lead to a pickup in economic activity, a
reacceleration in inflation and less rate cuts than the market expected.

Bonds kept on
rallying after the Fed’s pivot because that was the trend and there were no
signs yet that the contrarian view would come true. In Q1 2024 though, the US
data started to surprise to the upside and made the market to price out the
rate cuts. The data was the catalyst that led to a repricing in interest rates
expectations and to the change in the trend.

Once you build your contrarian thesis the tricky part is identifying the right catalysts. They are not based on just economic data. For example, the US Dollar bottomed in January 2021 after the Democrats won the majority in the Senate in the elections in
Georgia.

From there
the market expected more fiscal stimulus from the Democrats and coupled with
supply chain issues and the already huge monetary stimulus by the Fed, it led
the market to start worrying about inflation and an earlier Fed pivot. This Fed
pivot came in June 2021 with a hawkish meeting that gave the US Dollar the ultimate tailwind to start its massive appreciation.

This article was written by Giuseppe Dellamotta at www.forexlive.com.