Why the Contrarian is Buying

S&P500 daily at end of day

End of Day Analysis:

Stocks smashed through 2,040 resistance and closed above 2,050, setting yet another record high. Volume was more brisk than in recent days as these gains triggered a wave of technical breakout buying and short-covering.

Too often people mistakenly think contrarian investing means going against the trend. They see something they think has gone too-far, too-fast and are convinced the underlying data doesn’t support the move. They see themselves as a savvy contrarian investor when they bet against the move. But all too often this ends up being a costly mistake.

Contrarian trading has nothing to do with the trend or technicals. It is only about the crowd and its mood. It doesn’t matter what the underlying price action is. Sometimes it is contrarian to go against the trend, but more often than not it means betting on the trend no one believes in.

October’s plunge left traders with a cynical hangover. Even at record highs, they continue talking down this market and are certain we are on the verge of crashing lower. Many of these traders bailed out during October’s selloff and were left behind by the subsequent rebound. They are desperately hoping for the breakdown so they don’t feel so foolish for selling last month.

Unfortunately for these cynics, with so many people bashing the market, the contrarian trade is buying the breakout. AAII’s Asset Allocation Survey showed equity allocations are at 14-month lows. Stocktwit’s SPY sentiment gauge is 54% bearish, a full 16% more bearish than when the market peaked in September. All of these doubters will turn into reluctant buyers as the fear of a selloff is replaced by a fear of being left behind. Expect the market’s strength to continue pressuring underweight money managers to chase the rally higher into year-end.

Jani