Contrary Opinion

The theory of contrary opinion states that the vast majority of market participants think stock prices will advance, they usually decline.
Likewise, when the vast majority thinks prices will decline, they advance. In other words, prices will move contrary to what investors expect when those expectations have reached an extreme. The theory applies only when those expectations have reached an extreme. Notice that the theory does not consider the general economic situation. It simply states that the necessary and sufficient condition for a major market top or bottom is the existence of extreme bullish or bearish sentiment.

When you have an extreme reading in market sentiment, you must elevate that fact above all other indicators and economic data. It doesn’t mean that these other indicators aren’t important, it just means that when they conflict with an extreme reading in sentiment, you always defer to contrary opinion.

The major hurdle is that to apply the theory of contrary opionion you must overcome the fundamental ideas that are making everyone so bullish or bearish. If the picture of the economy looks extremely good, no clouds are in sight, and everyone is bullish, the fact that everyone is bullish becomes more important than anything else.