The stability and downside risk to contrarian profits: Evidence from the S&P 500

A large literature now reports the evidence for the profitability of contrarian trading strategies. We investigate the stability of such contrarian trading strategies and their ability to generate large, potentially ruinous, losses for their users. Specifically, we ask, are the annual profits earned by contrarian strategies sufficiently stable and loss-free to keep their adherents in the game and capable of reaping returns to such long-run trading strategies? We present tests with more statistical power than hitherto, reflecting practical aspects of the operation of contrarian strategies. Specifically, the strategies are implemented only for years in which the mean return of stocks in the buy portfolio exceeds that of the sell portfolio; in addition, for each strategy, we calculate the Calmar ratio as a measure of downside risk. Using the constituents of the S&P 500 index for the years 1990–2017 inclusive, we examine a variety of simple, ratio-based strategies and more complicated strategies based on formal valuation models. Overall, our evaluation makes us sceptical about the reliability of contrarian strategies as currently formulated. But of those strategies available, those based on discounted cash flow seem most likely to be profitable.