The art of contrary thinking is one of the most powerful tools a trader can use, and it’s a trait all truly great traders are familiar with.
What is the art of contrary thinking?
The art of contrary thinking is to train your mind to ruminate in directions opposite to the general public opinion; but base your opinion on current events and human behavior.
Humphrey Neill’s book, “The Art of Contrary Thinking”, the best known work on the subject, is based on the simple but powerful idea that:
“When everyone thinks the same thing, everyone risks being wrong”
Why Contrary Trade Works
By spotting situations where the consensus is extremely bullish or bearish, a trend change is imminent, as it is likely that the emotions of greed and fear have pushed prices too far from true value.
This is evident in events such as the stock market crash of 1987.
Here we have a short term self-fulfilling prophecy. When the change happened, everyone changed their minds at the same time, causing a huge uproar.
Of course, if you can step out of the crowd and take a counterpoint to these turns, you can make big profits.
Why the opposite thought will always be valid
While Humphrey Neil’s “The Art of Contrary Thinking” (published in 1954) is the most famous book on the subject, a century earlier there was a book on Contrary Thinking.
Charles MacKay’s book, “Extraordinary Popular Delusions and the Madness of Crowds” (published in 1854), covered three major financial crashes:
Tulip Madness, Mississippi Madness, and the South Sea Bubble. He reflected on how investors always push prices too far when caught in consensus:
“Men, as we have said, think in herds; we will see that they go mad in herds, while they regain their senses only slowly, and one by one.
It is clear that in order to be successful in trading, you need to think independently of the majority about important turns in the market.
Become a contrary trader
Gann was one of the greatest traders and traded in the early 20th century. He realized that human nature would always mean you had to think independently of the crowd to be successful.
“We cannot escape it (the emotion). Going forward, it will cause another panic in stocks. When it does, traders and investors will sell stocks, as usual, after it is too late, or in the later stages of a bear market”.
He was aware that human nature was constant and influenced the majority of traders:
“Thus, to be successful, the trader must act in such a way as to overcome the weak points which have caused the ruin of others”
How to plan for a major change
Gann was not just a writer; he was a successful trader and had an extraordinary track record of accomplishments in the stock market, for example:
Gann used to publish a forecast for the following year. In 1928 he published a forecast that predicted the date of the US stock market peak of September 1929 and that a Black Friday would occur, a year before the actual events.
In 1932, he also recommended buying stocks at the all-time low of the Dow Jones in June and July.
Gann was one of the most successful stock market investors of all time and developed a strategy to stand out from the crowd and simply let market action indicate where prices were going.
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