Let’s say you were to fall sick and visit a doctor. He prescribes you some medicine. Suppose you are unhappy with this doctor’s diagnosis and wanting a second opinion. Thus, you visit another doctor who gives an identical diagnosis and prescribes the same medicine. Still not satisfied, assume you visit eight more doctors and all prescribe the same course of medicine. What should you do under these circumstances? The logical course for you will be to take the prescribed medicine. Doing anything else is likely to be foolish as you would be jeopardizing your health. If all doctors agree on the proper medicine for you, then it is logical that you should take that medicine.
Now let’s change the circumstances. Suppose you were to visit ten investment gurus and all agree that you should buy a particular stock. What should you do under these circumstances? Here, the rational thing to do will be to avoid that stock because if all ten investment gurus recommend that stock at the same time, it’s likely that its price is too high because it already reflects the optimism of the professionals. You may end up losing money chasing the hot stock.
Below is an awesome quote by legendary investor, John Templeton:
“It is crucial to understand, and very few people do, that attaining superior investment performance has nothing at all in common with succeeding in 99% of other occupations. If you were building bridges and a dozen consulting engineers experienced in bridge building all gave you the same advice, you’d be stupid not to build your bridge their way. In all probability, if the experts all agree, their way is the right way to do it. You’d build a better bridge at lower cost if you followed their advice. But the very nature of investment selection process turns that scenario topsy-turvy. Let’s assume that every securities analyst you see says, “That’s the stock to buy!” You might think that if all the experts are saying “buy,” you should. But you couldn’t be more wrong. To begin with, if they all want it, they’ll all buy it and the price will build up enormously, probably to unrealistic levels. By the same token, if all the experts say, “It’s not the stock to buy,” they won’t buy it and the price will go down. It’s then, if your research and common sense tell you the stock does have potential, that you might pick up a bargain. That’s the very nature of the operation. It’s quite simple; if everybody else is buying, you ought to be thinking of selling. But that type of thinking is so peculiar to this field that hardly anybody realises how valid it is. They say: “I know you’re supposed to look where other people aren’t looking,” but very few people actually understand what that means.”
Therefore, it can be seen from the quotes and examples above that investing is unlike most of what we do in our daily lives. The best time to buy a stock is at the point of maximum pessimism and the best time to sell a stock is at the point of maximum optimism. This is contrarian investing. Warren Buffett sums it up best when he quipped, “Be fearful when others are greedy and be greedy when others are fearful”.