Countercyclical refers to a behavioral pattern of investment behavior or intent which acts contrary to dominant market investment trends. A countercyclical investor typically buys securities when their price falls and sells when prices go up.
True to the motto “buy on bad news, sell on good news” the countercyclical investor stands apart from most traders. These investors are sometimes called “contrarions” because of their contrary trading habits.
As with all traders though, the goal of the contrarian is to buy securities at the lowest possible price and to sell them at the highest possible profit. The countercyclical trading strategy is generally considered to be a high-risk game of playing with fire. However, in the best case this strategy can reap above-average rewards.
Research into behavioral finance shows that the average investor does not act rationally, but rather is driven by emotions. For this reason, the value of a stock often does not reflect its actual value. Rather, it is the result of panic-driven sales or euphoria-driven purchases, usually reflecting emotional trends.
The contrarian takes advantage of investor stampedes by investing in the opposite direction. When a particular industry is plunged into crisis and most investors are rushing to dump their shares, a contrarian sees his chance and takes these stocks off sellers’ hands at a dumping price. If the trend changes and investors begin to buy stock again, the contrarian’s gamble pays off: they sell the shares back to investors at a tidy profit.
The term countercyclical can also be used to describe securities themselves. Many stocks and other securities are highly dependent on key world market factors. The overall economic climate, economical and company-specific dependencies and many other factors can all have a direct effect on stock prices.
Stocks which follow overall economic patterns or trends in specific markets are referred to as “cyclical stocks” because they rise and fall in keeping with economic cycles. Stocks which follow a course that is contrary to the trending economic climate or market trends are referred to as “countercyclical stocks” because their rates do not follow economic highs and lows.
Shares with rates that remain relatively stable, such as those linked to consumer goods or telecommunications, are examples of countercyclical stocks. Their rates remain stable because demand for those products remains fairly constant regardless of the economic climate.