Contrarian Vs. Momentum

Contrarian investing involves hunting for stocks that are seemingly not trading up to their value potential. While a mainstream investor sees little value in a stock or a financial security from another asset class, and consequently avoids the investment like the plague, a contrarian investor recognizes a diamond in the rough and thinks he is getting a bargain. When investing in metals produced a loss for investors in 2004 while the broader stock market produced gains of 8 percent, contrarian investors who identified an opportunity would have chosen to invest in metals. By the following year, profits for such contrarian investors were more than 30 percent.

Momentum investors aren't afraid to jump on the bandwagon and invest in the most popular securities of that time. When Internet technology stock prices were reaching new highs in the mid-1990s, the companies went year after year without earning profits. Momentum investors didn't base their decisions on the companies' profits, and instead continued to invest because Internet stocks were making investors quick money. By 2000, as soon as the ride for these stocks was ending and prices began falling, momentum investors took that cue to sell shares until the next fad came along.

Contrarian investors look for financial securities that appear to be treated unfairly by other investors. The primary risk facing contrarian investors is that they misread an investment's potential and the financial security actually has further declines ahead, not gains. For momentum investors, the greatest risk is that they enter a position too late because a financial security has already seen its best days. In that case, instead of continuing its climb the stock price would head in the opposite direction, leaving the momentum investor with a financial loss.

Warren Buffett, one of the most highly visible stock market investors, has helped to promote a contrarian investment style. One of his famous sayings is, “Be greedy when others are fearful, and be fearful when others are greedy.” Professional money manager Richard Driehaus, who started his own investment firm in 1982, helped to promote momentum investing. His strategy is the opposite of Buffett's, as Driehaus advocates buying high-priced stocks and waiting for prices to rise higher before selling for a profit.