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It may seem to some that taking advantage of a crisis and profiting from it would be underhanded or lacking moral integrity, but from a trader’s point of view, nothing could be farther from the truth. The desire to make a profit is the grease that makes the wheel turn and the sole purpose free markets exist at all. Once you have accomplished that not so small feat of making a winning trade, you can donate some of your profits to charity if that will help you sleep at night.

It is the very nature of the markets to punish the impatient investor and reward patience. If you have your hard earned dollars at risk in the markets it is your responsibility to profit in whatever way you can. You must use every tool, every piece of information and every situation that presents itself to obtain an edge you can use to make a profit.

My regular readers know that I don’t take investing lightly. You’re money is at risk, you better keep your eye on it. Investing is not a hobby. There are far better and more enjoyable ways to lose your money. To play a “hunch” on a stock because of something you might have heard on CNBC is worse than flipping a coin although you might say, it could go up, or it could go down. You can see how it may appear to be a 50/50 call. Insidiously, it is much worse than that.

Consider that fact that once investment information is made public by the mainstream media, all of the information being disclosed is already reflected in the share price as suggested in the “Efficient Market Theory.” This would leave our investor/hobbyist buying in at the very top of an asset’s share price while everyone else (insiders/smart money traders) is selling. With the stock price beaten down to ridiculously low levels, our trader gives up, accepts his loss and sells at the market bottom. Our hobbyist has been slaughtered along with many, many others, an event that repeats itself every day the markets are open. Doesn’t sound like a 50/50 chance to me.

Companies like Goldman Sachs have built a century old empire using crisis investing to their advantage. When there is “blood in the streets” and an asset is despised and shunned by everyone, there lies an opportunity to reap the greatest windfall profits with the least amount of downside risk. The pros know this simple truth and are always alert to “contrarian” investment situations when they present themselves. They built their massive juggernauts on the bones of hated assets that the average retail investors flee from in the face of falling share prices. Therein lies the opportunity for tremendous profit and is the basis for all “Contrarian Investing.” As investing legend Jim Rogers puts it, “you wait until the money’s sitting there on the floor, and then you go over and pick it up.” That’s a true contrarian.

Trading Extremes

In order to be a successful contrarian investor, it is essential that you seek out “extremes.” Whether it is political risk, risk of inflation and it’s effect on dollar traded assets or the price of government bonds, natural disasters (and their effect on industry and insurance companies), acts of terrorism, government intervention (interference) or interest rate fluctuations, these situations create opportunities for profits. If you don’t take advantage of them someone else will.

When faced with an “extreme” trade, it is important to look for “obvious trades” where the information has been widely disseminated and therefore the trade becomes too one-sided. In the case of the U.S. Dollar trade, it has become generally understood that a crisis is in the making. With the Federal Reserve printing massive amounts of dollars, backstopping financial institutions with billions, unfunded social programs and a receding economy it is well understood that the dollar trade has nowhere to go but down. As investors pile into this obvious falling dollar trade (symbol: UUP, U.S. Dollar ETF) and the fact that “short interest” is overwhelmingly one-sided, a small amount of buying could create a sharp rally in the dollar’s value. This would in turn spark a massive “short covering” rally and wipe out the shorts by forcing them to cover their positions. This is another type of “extreme trade” using investors excessive optimism or pessimism as the catalyst for putting the trade on.

Investment Guru’s Rules of Trading

The one thing that all investment gurus have in common is that they all read “The Gartman Letter” written by Dennis Gartman. The following are Gartman’s “Simple Rules of Trading.”

1. Never, ever, under any circumstances add to a losing position… It will lead to ruin.
2. Trade like a mercenary soldier… We must fight on the winning side, not the side we think is economically correct.
3. Mental Capital trumps real capital… holding onto losing positions cost measurable real capital, but it also costs immeasurable mental capital which cannot be replaced.
4. Investing is not a business of buying low and selling high… it is a business of buying high and selling higher. Strength begets strength and weakness begets weakness.
5. In Bull markets, one can only be long or neutral, in Bear markets, one can only be short or neutral.
6. Buy markets that show the greatest strength… Sell markets that show the greatest weakness.
7. Think like a fundamentalist, trade like a simple technician. Be bullish or bearish only when fundamentals and technicals, as you understand them, run in tandem.
8. Trading runs in cycles, some good, most bad… Trade large and aggressively when trading well. Trade significantly smaller when trading poorly. In good times, even errors turn into profits. In bad times, the most well researched trades will go awry. This is the nature of trading. Accept it and move on.
9. Keep your technical systems simple… Complicated systems breed confusion, simplicity breeds elegance. The greatest traders of all time have used the simplest systems.
10. In trading/investing, an understanding of mass psychology is more important that a degree in economics.
11. Bear market corrections are more violent and far swifter than bull market corrections.
12. There is never just one cockroach… the lesson of bad news on most stocks is that more will follow until such time that panic prevails and the weakest hands exit their positions.
13. Be patient with winning trades, be extremely impatient with losing trades.
14. Do more of what is working and do less of what is not… if there is a secret to investing and life, this is it.
15. All rules are meant to be broken, but only very infrequently. True genius is knowing how infrequently it can be done and still prosper. Simple yet profound.

Contrarian investing offers the opportunity to hit the lottery without incurring the long odds associated with buying a ticket. You may lose on occasion, but the winners and profits will far outpace the losses. Contrarian investing is one of the most effective trading systems available to the individual investor. It’s results are consistent and the selection process is easy to understand. The only requirement is the ability to think for yourself and go against the crowd. If you are able to gauge the emotional responses which traders apply to their investment decisions (see rule #10), then you can profit from contrarian investing. Feel free to review these 15 rules before you place your next trade.