INVESTING: Betting against the crowd is a good way to invest

It’s time for a gut check on sentiment. In the stock market, sentiment is a contrary indicator, meaning that if everyone thinks the same thing (such as oil is going to $200 a barrel soon), your safer bet is to go the other way.

Wall Street history is loaded with juicy examples of this theory at work. One of my favorites is Time magazine’s making Jeff Bezos, the CEO of Amazon, Man of the Year in 1999, right before the tech market crashed.

“Fading the market”-an investment strategy used to trade against the prevailing trend-is a powerful tool. I use it all the time. The media pick up and distribute trends faster than ever before. We all know there is a food shortage going on around the world, and we all know one of the causes is the persistently high price of oil. A similar issue is the weakening economy. Open any newspaper or magazine and you will get a lot of bad news about the economy. Traditionally, fading this coverage has been a path to profits.

My feeling is, sentiment should be viewed in stages. First, come up with an idea. Second, find out how often that particular topic is being discussed in the media and by the public. Then, rank that frequency against other historical periods, if possible. Last, decide if the current frequency is truly at an extreme. If it is, then fading will put money in your pocket in almost every case.

Now, within these stages are degrees. Sometimes, public sentiment can be right for long periods before that sentiment reaches an extreme worth acting on. I also believe it is important to distinguish between what people say and what they do.

The current environment illustrates this perfectly. News stories about the economy and the stock market are negative. Line 100 people on the street, and they will mostly say they are feeling bad about future prospects, both personally and for the broader picture. They will tell you they are bearish regarding the stock market. The next question is the one that is not being asked, however. That is: What are these people doing with their portfolios right now? You would guess they sold everything, as bearish as they are. But reality is a bit different. People are bearish, but their IRAs and 401(k) accounts are still stuffed with stocks. That tells me we haven’t reached an extreme yet in bearish sentiment.

There are a lot of ways to rank sentiment levels against historical averages. Doing an Internet search as to how many times a particular term is mentioned in the newspapers is growing more popular. Another way is to compare the trend in question with other overblown moves and find out how far sentiment went before a sustained change took place. Recent examples of this are the tech move in 1999 and real estate as of 18 months ago.

These tools may help you figure out when oil is going to top out for good, but keep in mind that it may be years before that actually happens.