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Contrarian Investing? Forget About It, Cramer Says

“Mad Money” host Jim Cramer on Wednesday made no reservations about conveying his thoughts contrarian investing.

“I think it’s wrong. I think it doesn’t matter,” Cramer complained. “I think it’s really a treacherous way to invest.”

In the investment world, a contrarian is someone who takes a position that differs from the majority. If a particular sector is “hated” by most investors, a contrarian might want to buy in. After all, if few investors like the sector, a contrarian thinks there are few people left to sell, making it immune to big declines.

In many cases, the disliked sectors are “underweighted.” To explain what this means, Cramer listed the industrials and banks as an example of “hated” sectors. So “underweighted” means money managers have less of a percentage of industrials and banks than the percentage industrials and banks accounts for in the S&P 500 index.

“Portfolio managers are always trying to beat the S&P 500, which is their benchmark of performance. The way they can do it is to overweight a particular sector, meaning own more of that sector than is represented in the S&P or underweight a sector versus its percentage in the S&P,” Cramer explained. “If you think the industrials are going down you want to own fewer industrials, or be underweighted. If you think the banks are going higher you want to overweight the group.”

According to Cramer, recent surveys show the majority of money managers are “underweight” the financials and the industrials. This kind of “severe underweighting” means that if anything good happens, portfolio managers will rush to buy stocks in the “underweighted” groups, prompting a big rally.

As it turned out, Cramer said the contrarian trade worked for the banks, but backfired big time for the industrials. So what happened?

Cramer noted many industrial managers said things were weaker than people thought thanks to fears over Europe’s ongoing debt crisis, which means they didn’t meet their earnings estimates. Upon hearing this, the few investors who owned industrials sold their shares. The industrial stocks got hammered.

So even the contrarians think that Europe’s economy is only getting worse and they couldn’t take the pain, Cramer said, despite the fact they thought their contrarian trade would have been immunized against it. This time, though, Cramer noted the conventional wisdom was right and the contrarians were wrong.

To Cramer, contrarian investing is simply “too hazardous” to recommend. Instead of relying on sentiment, Cramer recommends investors pick stocks based on fundamentals. In other words, he thinks investors should only select stocks after researching the underlying company.

Read on for Cramer's Stocks to Avoid

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