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Chapter 8. The Worst is Behind You: The Contrarian Story

Chapter 8. The Worst is Behind You: The Contrarian Story

The Last Rational Investor

Jack was a loner with little faith in human nature. He was convinced that the rest of the world was irrational and becoming increasingly so, and he felt that herd behavior was the rule rather than the exception. As he read about a selloff on a blue chip company after an earnings report that fell short of expectations caused the stock to drop to $8 from its 52-week high of $45, he told himself that the stock could not go down much further. After all, the company had been around 50 years and had once been considered a market bellwether. He called his broker and bought 1000 shares at $8, convinced that it was only a matter of time before it bounced back. A few weeks later he checked the price again and the stock was down to $5, and he bought 1000 shares more, believing even more strongly that a rebound was just around the corner. Two months later, the stock had hit $2, and without a hint of self-doubt, Jack bought 1000 shares more and waited for his payoff. Four days later, the company announced that its CEO had resigned and that the stock had been delisted. The only consolation for Jack was that the stock price had finally hit zero and would not go down any further.

Moral: The crowd is more often right than wrong.


Guessing when a stock has hit bottom is the source of much talk on Wall Street and it is often the basis for investment strategies. Contrarian investors are often willing to buy a stock after a sustained price decline on the expectation of a rebound. Their belief is that a stock that has dropped 80% to 90% from its peak is much more likely to be a bargain to investors. In this chapter, you will explore the underpinnings of this strategy and any potential limitations. As you will see, bottom fishing can be lucrative but it can also be dangerous, and only investors with the fortitude to withstand reversals succeed with it.


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