There was a program on last night about people who’d been on one of those expensive property training courses and were now facing massive losses. Some people paid £140,000 for flats they’d never seen, because they trusted the valuation of the property company. Now they’re selling for around half that! The presenter was having a field day asking questions like “How devastating is this for you?”

I’m sure he was just willing them to cry. Every man and his goat are now coming out of the wood-work saying how they predicted the crash and sold their property for a massive profit years ago.

There were countless arguments about house price to income levels being at record levels and counter arguments about affordability because of low interest rates. There was no sure fire way of predicting when things would turn.

Having bought for the first time a few years ago I’m finding it interesting watching the general news flow. It seems to me that you can pull out as many statistics as you want, but the housing market is no different to any other market – sometimes they over heat and sometimes they correct.

Human beings are irrational and will often overreact at both ends of the scale. The housing market didn’t turn until sentiment turned. A year ago some friends were still in bidding wars for the property they wanted, now all we hear about is people not selling because ‘they want to wait and see’. Of course there have been many reasons behind the change, but the main driver is a simple change in sentiment.

The stock market works in exactly the same way. I will only buy something if I think that there will be someone else willing to pay more for it in the future. During the dot com boom people were lapping up stocks that were yet to make a penny because they believed that some other fool would soon buy it for an even bigger price.

Recently the Chinese stock market has slumped from record highs. There were stories of cleaning ladies cashing in their life savings to play the stock market. If that isn’t a sign of a bubble about to burst I don’t know what is. Just as there was plenty of anecdotal evidence of people jumping into the buy to let property market because they thought property would always go up.

It can often pay to go the other way: to sell when the crowd are buying and to quietly accumulate while everyone is heading for the hills. However knowing when to follow the lemmings and when to follow your own path can be a tricky decision. It wouldn’t have been sensible to scoff at those panicking on the Titanic, settling down to your port and cigar while everyone else was heading to the life boats. See my tips on how to be one of the canny contrarians below.

Be one of the canny contrarians with contrarian trading and investing

Contrarian trading & investing involves spotting when the crowd has got it wrong and knowing when to go the other way.

Some of the best things I’ve seen on contrarian investing have come from Barry Ritzholtz via his blog

Here’s a summary of Barry’s thoughts taken from here:

Consider the following aspects to thinking contrary to the crowd:

1) You cannot be a full time contrarian. Why? The crowd is actually right most of the time. Remember, they are what moves markets, why equities go up, why a pop song becomes a number 1 hit. Indeed, the crowd is why indexing works.

2) This gets reflected in such cliches as “Don’t fight the tape” and “The Trend is your friend;” The crowd is neither right nor wrong, but instead is its own truth, a self fulfilling prophesy. This leads to some unexpected outcomes.

3) Beware extremes: The crowd will take markets much higher and much lower than they should go based on reasonable, logical common sense metrics.

4) There is safety in numbers. No one gets fired for groupthink. In every nature documentary that you have ever seen, its the gazelle at the edge of the herd that the lions devour. The rest of the herd is safely huddled together. That’s the anti-contrarian lesson (if your a gazelle)

5) Whenever the crowd loves or hates something, it worth noting. That’s when contrarians are the ones who will make a giant score. Think short-sellers in Enron or Tyco, or the buyers of tech stocks in late 2002.

6) Where Contrarians shine is when the crowd morphs into an angry mob. Once the bulls become convinced the market is invincible, their full throated cries will be readily apparent. So too, the bears, usually in the depths of a recession.

Contrarian indicators

Ritholzt has also written a neat guide to the best contrarian indicators that you can use. These vary from technical indicators to more subjective things like magazine covers or TV shows. He distinguishes between two different types of contrarian indicators: ‘internal’ market signals and ‘external’ societal displays.

“Contrary Indicators are the data points, signs, and events whose actual significance to the market is the exact opposite of what their initial impression suggests. These counterintuitive signals can reveal when great masses of investors are collectively reacting emotionally to a given event or stimulus. When the herd becomes violently emotional, they typically “shoot first, and ask questions later.” This invariably results in poor investment decisions.”

Ritholtz has written a thorough guide to the world of contrarian investment here:

Internal market signals are made up of actual market activity. My favourite are the equity put/ call ratio and the VIX.

The equity put/call ratio is a measure of the amount of options traders predicting that prices will rise vs. the number predicting prices will fall. 80% of options expire as worthless so it gives you an idea that when this ratio reaches an extreme level, there’s a fair chance that many people are wrong.

The VIX options volatility index is a measure of the jumpiness of US options traders. It is also known as the ‘fear’ index because when it rises high it usually represents fear in the market. Low readings can represent complacency. Last Thursday was a great example. You can view the VIX on many charting sites like ($VIX). Last Thursday the VIX hit its lowest level since February, this indicated complacency yet the news flow continued to be poor. The next day markets were down 2%!

External signals are made up of things not directly related to the stock market. The classic is the American Association of Individual Investors sentiment survey (AAII). When AAII readers reach extreme levels or optimism and pessimism, historically it has been a good indicator of a reversal. Another more subjective external signal is the magazine cover or TV shows. When there are an extreme number of covers or media displaying an extreme message, it could be time for a reversal.

Contrarian Investing isn’t easy, but understanding some of the key ideas may help you to stay one step ahead of the crowd, at least some of the time.

New forex trading system

There’s a huge buzz surrounding the launch of the new Ultimate FX Predictor. This comes from Keith Cotterill, the same guy behind the very popular Don’t Tell The Professionals.

I should have my copy on Friday and I will be putting it through its paces. In the meantime, you can find out more by following the link below.

Please note: I have high hopes for this, especially as it is co-pubished by Nick Laight (my publisher).

What’s more he is personally underwriting the guarantee!

Over to Nick…

My trades

I closed my FTSE trade just before the FOMC meeting minutes, it of course went higher immediately! However, looking back it was the right call, especially with Friday’s sell off. I took a small loss shorting the USD/ GBP at 1.9700, it dipped into profit briefly but has been ranging around the level ever since. I cut my losses where I could.

I’ve been making some short term Forex trades using a nifty system that a Market Maven member has sent me. I’m still getting to grips with it primarily, but I think it has real potential. I’ll update more next week.

This week’s hot trading buttons

Last night’s RICS housing survey hasn’t hit sentiment too hard today, but we’ve got US PPI and Empire State Business Conditions Index around Midday. Average UK Earnings and bonus data arrives on Wednesday morning followed by US core CPI around lunchtime. US Unemployment Claims come in on Thursday with Friday being a relatively light day on the data front.

All of this is mainly linked to inflation which is the great concern for central bankers at the moment. A recession would be bad but having your earnings eroded by 5% inflation could be even worse in some ways.

Trading wisdom

“Never sell at the top because you can never predict when the top will come – and then after that, it’s hard to sell,”. – Anonymous

Until next week,

I’ll finally be writing part II of our guide to creating your own trading system.