Going against the crowd is a proven strategy for making money in the stock market. A common way of doing this is to do the opposite of what most private investors are doing. For example, if you had bet against commercial property in 2007 when Joe Public was piling in, you'd have made huge profits. But did you know that you can also get rich by doing the opposite of the City's wisest men?
When stockbrokers' analysts are collectively negative about a particular share, it often goes on to perform very well. A 2001 study by three American researchers – Brad Barber, Reuven Lehavey and Maureen McNicolls – found that in the previous year buying the stocks that Wall Street analysts were strongly recommending clients to sell and selling short their strongest 'buys' would have returned a whopping 80 per cent.
It might seem odd that analysts' advice works in the opposite way to which it is supposed to. After all, they are paid generous amounts of money specifically to give expert advice on a handful of companies. They have excellent resources at their disposal and they enjoy unrivalled access to management at the companies that they research. So, why do their strongest 'sells' end up doing so well, while their strongest 'buys' do so badly?
Textbook financial theory says that you can only earn above-average rewards for taking above-average risks. So perhaps the shares that most analysts recommend selling are much more risky than the rest, such that any extra return from them is merely compensation for this. The academic definition of risk is price volatility. But we found that last year's top analyst 'sells' in the UK had lower historic volatility than their 'buys'. It seems likely, therefore, that something else is going on here. Behavioural finance – which addresses the influence of human psychology on investment decisions – offers a couple of potential explanations.
