Risks for Contrarians
At first glance, it might seem that simply acting in a contrary mode is itself a risk. In some respects, it is; going against the thinking of the majority might be thought of as a form of reassurance risk. Allowing a majority to dictate decision making is very reassuring, but it takes more strength to make individual decisions that most people dispute. The fact is, going along with the majority is a much greater risk, in virtually every way.
Other risks have to be kept in mind and, as a fundamentalist, you need to make specific policy decisions about how to manage the various risks. As a contrarian, you might reject the popular thinking about risk, especially if you have ultimate faith in fundamental analysis and, at the same time, you decide to defy the traditional thinking about risks.
First is the concept of diversification. The general opinion about smart investment management states that you should never invest all of your capital in one place; rather, you should spread it around so that you never stand to lose everything on one change. Diversification can mean several different things. It may mean that within the stock market, you should not buy just one stock. Or you should not put all of your capital in the stock of a single industry. Or you should diversify between equity and debt investments. Or you should have some portion in domestic and some in international stocks. Or you should have some of your portfolio in real estate or precious metals.
However you define diversification, it means spreading your exposure to risk among many dissimilar investments. So as a contrarian, do you accept this premise? This is one of the areas in which it generally seems to make sense to go along with the broad thinking, that it makes sense to spread risks. In practice, you may be acting as a contrarian to follow the advice, especially when you look at how most individual investors act. They may have too much of their capital invested in a single stock or, equally as dangerous, in a single strategy. Thus, if the market goes opposite of the way they think, they will lose from lack of diversification in strategy. Many investors subscribe to the theory of diversification but fail to put it into practice.
If you have limited capital, you can diversify by investing in mutual funds rather than buying your own stocks directly. The cost is lower and diversification is automatic, although you place your trust in the fund's management rather than doing your own analysis. Your investment decision is limited to the selection of a mutual fund, but you have no say in the decision of which investments to buy. Many motivated investors prefer to sacrifice diversification in exchange for having more control in managing their own portfolios.
Great emphasis is placed on market risk, which of course means the risk that the price of stock will fall. This is usually a form of short-term risk and, as you have already seen, short-term investment strategies can be used speculatively or even for the timing of long-term decisions. However, we suggest a contrarian point of view for fundamentalists: Ignore the short-term market risk. Make investment decisions using the dependable fundamentals, using and applying a long-term point of view about a company's investment value. Ignore the day-to-day changes in price insofar as they affect decision making, and track stock price movement only as a matter of vested interest. One of the satisfying things about investing in the stock market is price watching, especially if you are not likely to change a long-term strategy based on a day's price movement.
So you may ignore market risk as it applies in short-term changes, recognizing that the real value of your investment is its worth many years from now, the reward for well-researched selections of growth stocks.
Let's segment market risk into two parts. The more popularly understood is the short-term changes in market price. The other longer-term growth-oriented risk is of greater concern to the fundamentalist. Remember, the market rewards investors for taking risks; otherwise, there would be no interest in the stock market. Equity investors make money if they hold onto growth stocks for many years. As company profits grow, so does the equity value of the investment. With this in mind, the daily fluctuations in market price have no immediate interest because it means nothing in long-term fundamental terms.
Knowing which risks to follow and which ones to ignore is the best method for limiting your exposure to risk. In some respects, fundamentalists do not suffer from market risk in the same way as speculators do because they are not interested in immediate price movement. Speculators are highly vulnerable to immediate market risk because they intentionally expose themselves to high risk as a means for seeking high, short-term profits. But there are important differences. If you pick stocks using fundamental analysis, you will earn profits over time, just by applying sound ideas consistently. However, speculators are assured with equal certainty that they will ultimately lose money. That is true because of the nature of high risk. Speculators eventually lose because it is increasingly difficult to always make a large profit. They are constantly exposed to high risk and cannot consistently beat the odds.

KEY POINT
Market risk can be ignored to the extent that it represents a short-term risk. Your concern should be for long-term growth prospects rather than day-to-day price changes.