Contrarian and Momentum Investing

No one knows when a stock market crash will come, though some investors believe they can time the market. Followers of technical analysis believe that they can use historic trends in prices and volumes to buy and sell and outperform the market. These technical analysts believe that the Efficient Market Hypothesis--the theory that stock prices already capture all information--does not hold. In particular, they believe that the Weak-Form of the Efficient Market Hypothesis does not hold.

Some investment strategies have been shown to outperform markets, and so there is some evidence of violations to the Efficient Market Hypothesis. Examples of such investment strategies include:

  • Contrarian Investing. Followers of this strategy buy when prices fall and sell when prices rise contrary to the general trend of the market.
  • Momentum Investing. Followers of this strategy sell as prices fall and buy when prices rise to participate in the existing trend of the market.

Below is an infographic of historic declines in the U.S. stock market. If you had been a contrarian investor at those points of time, would you have been profitable? What if you had been a momentum investor?

Source: Infographics Archive