A bubble is formed when valuations deviate from intrinsic value due to a crowd. A contrarian is one acts opposite of what a crowd does. So what is a crowd?

In the dictionary, a crowd is a gathering of individuals but that is not the definition we are looking for.

A psychological crowd is formed when
1) the sentiments and ideas of all the people in the gathering takes one and the same direction, and
2) their individual personality disappears.

In this definition behaving with the crowd is not dependent on the number of people. An isolated individual who displays those characteristics is a member of the crowd.

Your actions doesn't determine whether you are with or against the crowd.
So if you merely buying when everyone is selling or selling when everyone else is buying, you are part of the crowd. Your actions may coincide with what true contrarians are doing, but your basis for acting are totally different.

The psychological crowd is emotional and acting rationally puts you against the crowd.
Being against the crowd means to recognize crowd behavior, resist crowd influence and act after reasoning, deliberation and analysis. Even if you buy when the crowd is buying (after due diligence that the price is still lower than intrinsic value), you are acting against the crowd.

Some examples:
If you, like me, have lost a sizable amount of net worth (over $20,000 for me) last week, you might have felt the urge to pull out of the market. You might feel upset, angry and depressed. You might have went to read on various bloggers and post and selectively acknowledge why and how the bear market is here, and set to get worst. After which, you feel vindicated for selling everything. That, my friend, is a crowd trade.

On the other hand: Warren Buffett bought a stock and you followed him? If you didn't do your own diligence, analysis and reasoning, that is a crowd trade too.

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25 comments
slapmeplease

Invest based on huat

Simpleinvestorsg

Reply to @slapmeplease : the best way to invest

zeeq

So what is the crowd buying now? Singtel?

Simpleinvestorsg

Reply to @zeeq : That's right., FOMO is a sign of it. That might be the most widely spotted one. But other emotion such as regret, pride (at making a good trade), anger and sadness can create such effects as well. The problem with crowd trades is that one mindlessly accepts the emotion of the crowd due to contagion, and acts as if hypnotise, sometimes doing things that are against our best interest. This is most visible at the peak of a bubble (e.g one bitcoin for a year of salary) but I think it affects us all the time in less ways. I've realized for myself, learning to recognize this emotion and consciously keep it in track (writing it into my investment plan) works better.

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Zumou80

Just a word of caution here. Intrinsic value is determined by market assumptions (Coe and terminal growth or market multiple etc). Markets have been largely influenced by liquidity in the last 10 years so using a 10Y av multiple in such case may still be ascribing Too little mos in a large global liquidity event. At the end of the day, your definition of what is crowd what is not.. is trying to split fine hairs. u may be happy to buy a stock that will give u 10% annualized returns today using multiple of 18x but in a liquidity drain event that multiple may only be 15x (less money in market overall so caps overall valuation). Assuming all else equal, ur annualized return will be less than 10% and it will be a large drawdown at the start before recovering so impact on IRR not low.

Simpleinvestorsg

Reply to @Zumou80 : I've gotten an answer from the above definition of a psychological crowd, so good for you if you can get something from it. Yield is always an important focus, especially free cash flow yield, but when the whole market is selling in a panic or in a bubble, being aware of our own emotional state may help to rein our actions.

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WolfOfHougangStreet

There's never a bad time to talk about crowds and herd mentality. Hahaha

The way I see it, it boils down to one fundamental question which is more applicable to those who practise FA: Can you, as an individual, have enough conviction in your analysis such that it stays the same 1) no matter how much the price fluctuates and 2) no matter what others say?

If your decision or analysis can so easily be wavered by the opinions of others and price fluctuation, it raises the question on the underlying reasons for buying a certain stock - you are probably part of the crowd. That is not to say that we should not listen to alternative viewpoints, but rather, take in every opinion and evaluate which ones are noise. And noise is usually motivated by emotions such as fear or greed.

Oh, and it goes without saying that those who make decisions purely based on the opinions of others (no matter how godly the source of info is) are by definition, PART OF THE CROWD.

tl;dr
can make well-informed and independent opinions = individual
anything else = crowd

ivanhoe

Think of it this way. The market is a legalised gambling joint, you against somebody else, be it a crowd, and you wait to see who can "move" the price. Who do u think will win? Who constitutes the crowd? The banker with inside knowledge? the BB with their massive funds? the influential players (like Muddy H2O) with their shorting first, then tell u the irregularities in the company? U are not trading against the crowd, u are trading against these players with money, influence, and the power of their algorithmic super-computers. My friends who are still in the market rationalise that they r playing for "pocket/coffee money" only, in other words, these to them r pennies they can afford to lose. What r u playing for?

theintelligentinvestor

You're right.

The true value investor will not buy because the crowd is buying (herd) nor because the crowd is selling (contrarian). This investor will probably be better off if he acts as if there is no crowd, no market and no stock.

TUBInvesting

It's really deep. But it seems like doing things differently doesn't constitute contrarian, your views to do things differently must be unique as well.

Uniquely Contrarian.

wellhandy

i bought an iphone. seems like a crowd trade too.

SilosInvestor

Reply to @wellhandy : Yes. I recently started using Kakao Talk instead of WhatsApp with my SG peeps, just to be a contrarian, only to realize social connection is few and far between from thereon.

SilosInvestor

So does a crowd trade by your definition then include buying a company with huge daily trading volume and highly covered by analyst and fund managers?

Simpleinvestorsg

Reply to @learningboy1988 : I don't know, haven't thought about daily trading volumes. A crowd trade is one that you are influenced to make due to emotions.

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