Being a Contrarian
My best friend doesn’t buy stocks. However, a month ago he phoned me up asking whether I was buying Twitter. I replied that ‘I wasn’t touching it even with his money’. Then I heard him say: ‘Surely if everyone else is buying it, then maybe I should as well’. This conversation made me recall the ‘Stupid Test’. This is probably the best test ever devised to judge whether a particular investment or trading decision is the right one.
And here is the best part about this test. You don’t have to have any investment or trading knowledge at all to carry it out. In a nutshell, the test’s principle is that if trading idea sounds like easy money, then most likely you are not the only person who thinks it. There are probably many others who think it too.
Since 90% of people who play the markets lose money, there is a very high probability that the investment idea in question is a bad idea.
Most people don’t realise that the best trades are those that are absolutely boring, unpopular or just dead difficult. Actually, scratch difficult, let’s say ‘impossible’. The Twitter stock rage is a classic example of the stupid test in action – and how a lot of people just failed to see this train wreck approaching.
The overwhelming hype and excitement surrounding Twitter stock should have been warning enough. It was a warning because usually, when everyone is expecting a particular market to do something, it does the opposite.
If everyone is bullish on a stock – such as the investors who thought Twitter would skyrocket to the moon like Google – it means they have already bought in. If everyone has already bought, then there is nobody left to buy. If there is nobody left to buy, then demand dries up, supply opens, and therefore the stock falls. This is the way the markets have always operated, and will continue to operate.
But stocks are not the only kind of ‘animal’ that the stupid test applies to. Other assets, such as precious metals, are not immune to it either. The unpopular and impossible trades are the ones where the most money can be made.
In 2004, people still had the bitter memory of the dotcom crash of 2000 still fresh in their minds. Web stocks were still unpopular. So when Google went public, its shares were considerably undervalued. Compare that with when Facebook went public. Not only were its shares extremely popular with the masses, but it turned out that some big players like Goldman Sachs were selling 50% of their holdings.
The smart money had already made their money in Facebook, and now they were dumping it on to the herd. But consider this. Which markets are unpopular with investors right now?