You might be familiar with our contrarian philosophy of trading. In short, as contrarians, we look for stocks that have had bullish stock price action and despite that, investors continue to have doubts and negative feelings about the stock. The idea is that the large number of doubters represents a lot of sideline money. As the stock moves higher and higher, at some point those doubters capitulate, and if they all pile in at once, that creates a fast and furious rally in the stock, which is especially profitable for option players like us. If the capitulation does not occur all at once, it can play out over a longer period, initiating a long-term steady rally which can also be very profitable. Similarly, for bearish bets we look for the opposite setup; negative price action for a hyped-up stock.

As we get to the end of 2019, I’m looking at what stocks would fit these criteria. It may give us a pretty good list of trade ideas going forward.

Bullish and Bearish Contrarian Setups

To find a list of bullish setups, I first looked for stocks which have outperformed the S&P 500 Index (SPX) this year. With the index up over 25% so far, any stock that beats this I would call having positive price action. To layer in sentiment, I looked at multiple data points to confirm investors had become more bearish on the stock. Specifically, I included stocks where option players, short sellers, and analysts were all showing a more bearish view on the stock. Specifically, here are the criteria for this screen:

  • The year-to-date return is better than the SPX.
  • There was an increase in short interest.
  • Percentage of analyst "buy" ratings declined on the year.
  • The Schaeffer’s put/call open interest ratio (SOIR) is greater than one.

This is a pretty good starting point if you’re looking for some bullish stock trades going forward.  

Naturally, I reversed the criteria to find stocks that we may look at for bearish stock plays, or maybe simply stocks to avoid. Specifically, the criteria are:

  • The year-to-date return is negative.
  • There was a decrease in short interest.
  • Percentage of analyst "buy" ratings increased on the year.
  • The SOIR is less than one.

Indicator Performance

Below, I show some evidence that this is a valid indicator. I used the same criteria as above for finding bullish and bearish setups at the end of 2018. Then, I summarized the return through the first three months of this year. Looking at the average return and the percentage that beat the S&P 500 through the first three months of the year, the bullish setups performed the best and the bearish setups performed the worst. This was despite the fact that 96% of the bearish setups were positive, the largest of any grouping. Note that only eight stocks met the criteria for a bullish setup.

The table below shows how these screeners performed two years ago. That is, which stocks met the criteria during 2017 versus how they performed through the first three months of 2018. In this case, looking at the average return, the bullish stocks underperformed stocks that were neither bullish nor bearish. They did, however, have the highest percentage that beat the SPX. Where the screener really shined was finding bearish setups. Those stocks lost an average of 10% through the first three months, with only 20% beating the index and only 13% of them positive. These were great stocks to avoid or short at the beginning of 2018.

Finally, before you blindly buy the bullish setups or short the bearish ones, here’s a cautionary tale. Look at the performance of this screener in 2016 (looking at the returns through the first three months of 2017). The stocks meeting the bullish criteria performed horribly while the stocks meeting the bearish criteria raced higher. It wasn’t even close. The stocks that had a bullish setup averaged a 1.2% return with just 31% of them beating the benchmark. Compare that to the bearish setups which averaged a 15% return through the first three months, and 53% beating the benchmark. 

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