Contra Index is a term used to classify the amount of market contra, leverage and margin play. In general, the higher contra index is, the faster small cap stocks will rise.
The reason behind is contra normally for short term play. This applies to high leverage and margin as well because high leveraging on a margin account has a greater amount of risk if dragged too long. Thus, they are more suitable for short term position.
Next, why small cap? Retailers like to contra because they do not have much money to pick up especially those speculative counter that not suitable for long term. Basically, if you are confident to a counter to perform in long term, you will pick up the stock or buying it using CPF. Besides, some risk takers might perform leverage trading to maximize profit versus time frame in this period as well.
Speculative small cap is not healthily to the market. Generally heavily trading on speculative small cap indicates that the market is moving towards a risker direction and could easily collapses (might be final wave of Elliot's Wave). Reasons:
- Firstly, ever rising of speculative small cap generally increases the market price ratio against earning and fundamental value. This leads to gradually cashing out by fundamentalist to transfer to other low risk (low PER) regions.
- Secondly, retailers will turns more radically high leveraging due to human nature - gambling, greed and pride. High leveraging causes high tendency of market crash when wave followed by another wave of margin call.
- Thirdly, as trading volume increases, brokerage risk control will break loose due to the competitive business nature (or broker to increase trading limit for higher commission earn). Hence, investors' exposure definitely will increases by opening more positions.
This summarize to:
The general strategy for high contra index scenario is to sell and lock profit. Avoid speculative counters if possible. NOTE: Greed kills.
The cash you prepare after locking down profit is for bargain hunting. With waves and waves of margin calls, force selling and nervous selling, one shall able to collect and buy cheaper stock for long term. Another thing to remember is, never lose your capital.
Explanation of Strategy
When market's health going down, the risk is much more higher (price too high also contributes to high risk). Sell and lock profit for most of trades by performing target price and cut loss price. You can lose all your profit in one two bad trades hence trades within your risk appetite.
Why never lose your capital? A simple mathematic will tells you why. (Link for the simple calculation of Cost of Capital Loss)
Advanced Strategy
- Contra index high. Reaction index low.
In this case, it is double edges sword scenario. Market can ignoring bad news due to bullish sentimental. Take this opportunity to cash out while everyone is still buying. - Contra index high. Cash index low.
Sell or short smartly. Those who believes in karma can buy Put warrant. If you wish to continue to trade, you may choose to hedge with Put warrant as well.
