Chris Johnson

Stay One Step Ahead of the Crowd

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Contrarian investing is a tricky thing. It's not as simple as saying that you're bullish when the market is bearish.

Sure, the simple concept of being in an investment before it becomes the "hot item" is easy to understand. But it's the execution of the theory that can wreak havoc on investors.

The reverse is even more nerve-racking -- stepping away from the market or a sector when it appears to be simply over-loved. It's like trying to break up with a girlfriend or boyfriend who's done nothing wrong. But for all the trials and tribulations, the proper application of contrarian theory can propel a portfolio to powerful gains.

Contrarians Love a Crowd

Where most investors go wrong with this approach is to simply say "black" when everyone else is saying "white." Merely going against the crowd will get you steamrolled more often than not. It's like trying to win a water fight with a squirt gun when the other guy's using a fire hose.

Contrarians actually like the crowd. That's right, I said we like the crowd. It's just that we like the crowd behind us.

"If you ain't first, you're last!" are words ripped from the recently popular movie "Talladega Nights" (I can't believe I'm admitting to knowing anything about this movie). This is the same attitude taken by the effective contrarian investor. This is why we watch "the crowd."

Always Know Where the Crowd Is

One of the more effective ways to watch the crowd is to key on what the analyst community is telling its followers. Since the crowd follows and rarely leads, picking up on trends in analyst recommendations offers a view of where the money is flowing … or getting ready to flow.

A common misconception is that a large percentage of analyst "buy" recommendations is enough to be bearish on a sector (i.e., saying "black" when everyone is saying "white"). This is not enough. You must consider the trend in ratings along with the technicals of the underlying security.

One way to apply analyst recommendations is our weighted analyst rankings for exchange-traded funds (ETF).

In short, we calculate an ETF's overall buy/hold/sell rankings from a weighted average of its member company rankings. We use this data to track when the pipers that lead the crowd are beginning to change direction.

It's important to note that the trend in recommendations is often more important than the absolute level of buys or sells. Equally important is the technical health of an ETF.

The saying "the trend is your friend" is no truer than when combined with a bullish analyst community. An ETF is likely to continue an uptrend despite an extremely high percentage of buy ratings. However, it's when the technical health of an ETF begins to stumble that an overwhelmingly bullish analyst crowd can be treacherous.