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A Story of Contra and Contrarian

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In some stock markets, like Singapore's, an investor can buy a particular stock and sell off the same stock without paying any money if the sell order takes place within the Trade day (T) plus another 3 market days (so called T+3). In certain markets, the opportunity to do this is limited as the investor will have to buy the stock on the same day that you put the buy order. Singapore used to have a longer contra period before it was changed to the one we have now.

So is contra trading a good way to make money? My belief is that this is almost like gambling. Quite a few people trade soley on contra, putting in a large bid order and hoping that within the time period, the stock will rise enough for them to take profit and sell off without paying for the stock. They will also rack up losses too if the stock prices dive for any reason. So it is actually taking a bet that within about 4 days, the stock will rise enough to make a profit after subtracting all the costs of brokerage and associated costs. In my eight years of investing in the stock market, I have only made 2 contra trades (and one was in error- to cover for selling more than I bought).

The only party that stands to win in contra trades are the brokerages because these contra traders tend to be big traders and rack up huge fees for their large amounts of trades. So my advice is for people to stay clear of contra trading, always put in a buy order only when you have the funds to take up the order and buy it outright. If you don't and the stock prices go down on T+3, you would suffered losses, even if the same stock goes up a lot the next day.

What is Contrarian then? It is a trading mindset where the investor actively searches for a stock that no one wants to buy or hold which has actually attractive P/E ratios, Price to Book or PTB ratios (the price relative to the net assets[total assets-intangible assets and liabilities] that the company has) some also look at PEG ratio(basically P/E ratio over EPS[earnings per share]). This is a very hard way to trade. It is in reality trading against the herd mentality. When everyone is selling the stock, you buy (provided that the above ratios are met) and when everyone is buying the stock, you sell.

Rationale behind this is that sometimes, market reacts badly to news that a stock is facing say a lawsuit or news that the management is implicated in some negative news. The market may overeact such that the ratios of the company becomes so attractive that a contrarian investor will step in and buy. In a way, it is quite similar to value investing, where an investor buys into a stock when it becomes cheaper with regards to these ratios. So if you look at the chart above, the returns of an initial $150,000 invested in stocks with low PTB ratios over a period of about 17 years would have earned you around $1million according to the Business Times on 23 July.

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