Our contrarian strategy is not as simple as taking the opposite side of the public’s widely held viewpoint. A stock that goes higher and higher for an extended amount of time will naturally gain a lot of positive sentiment. That’s not an immediate signal to buy. In fact, going against the price trend is always a tough way to play the market. Instead, we look for stocks where the sentiment is counter to the established trend. In other words, we look for stocks going higher, despite a significant amount of pessimism.
The reasoning is that the pessimism indicates a lot of investors have been avoiding that stock. If that stock continues higher, at some point the sentiment will change. If just a small portion of all those bearish investors capitulate at the same time, money can flood into the stock, leading to an energetic rally. The fast and furious rally is especially beneficial to us as option traders. This week, I’ll screen for stocks based on this philosophy.
Trading Ideas for Bulls
For bullish contrarian plays, the first thing I’m looking for are stocks that have outperformed the S&P 500 Index (SPX) so far in 2018. Out of these stocks, I’m looking for stocks in which the sentiment has become more bearish. I verify the sentiment is more bearish by the following criteria:
- Short interest has increased.
- The percentage of buy recommendations has decreased.
- The Schaeffer’s put/call open interest ratio (SOIR) is above one, which signifies more put open interest than call open interest.
The table below meets all the criteria laid out above. This can be a good starting point if you’re looking for some bullish stock trades going forward.
Trading Ideas for Bears
As you would expect, I reversed the criteria to find stocks that we may look at for bearish stock plays. These are stocks which have done poorly so far this year, yet sentiment has become more bullish. Note that this screen returned over 60 stocks. I only show the 20 stocks that had the biggest market cap. Specifically, the criteria are:
- The year-to-date return is negative.
- Short interest decreased.
- The percentage of buy recommendations has increased.
- The SOIR is below one.
Breaking Down Past Performances
The table below shows how stocks performed last year based on the contrarian bullish/bearish setups described above. This is based on 2017 data through the end of August. Then, it summarizes the stock returns over the next six months, or through February of the next year.
The bullish contrarian setups averaged an 8.74% return, which actually underperformed the S&P 500’s return of just over 10% from September of last year through February. This average, however, looks to be dragged down by some big losses. The median return of these stocks was 14%. Also, even though 65% of the stocks were positive — about the same as stocks that did not signal — the bullish contrarian setups beat the SPX at a much higher rate than other stocks.
The bearish contrarian stocks, meanwhile, underperformed by every measure listed. Furthermore, I noticed a lot of the stocks on the bearish list were oil stocks. Getting rid of those stocks since they’re so correlated and reliant on oil prices, the returns for those bearish contrarian plays get even worse.
I would say the indicator worked out well last year. That’s not a license to blindly buy and sell based on this one indicator though. To make this point, look at the table below showing how this indicator fared in 2016. The bullish contrarian setups performed poorly compared to other stocks. Don’t base trading decisions off of one simple indicator. A screen like this is a great way for ideas though to be researched further.
This post was originally published on *this site*