intellectually or intuitively understand its workings, from using the strategies consistently. The success of contrarian strategies requires you at times to go against gut reactions, the prevailing beliefs in the marketplace, and the experts you respect. All of us pride ourselves to some extent on our individualism and ability to tough it out using our own thinking. In practice, as the investor psychology we will examine demonstrates (and as my experience bears out), its a nightmare. I kid you not, nor do I exaggerate. That is the bottom line of why contrarian strategies are so rarely followed.

In the process of developing these strategies, I have had the privilege of talking to some of the leading psychologists studying market decision-making. Although they have provided outstanding research identifying many behavioral errors, they have not as yet fully recognized just how lethal these psychological pitfalls are for investors.

It is one thing to have a powerful strategy; its another to execute it. In 1862, George McClellan, the Union general who built and commanded the powerful Army of the Potomac, was considered a brilliant strategist. Not only did he have superior numbers when Lee and Stonewall Jackson invaded the North in the early fall of that year, but McClellan had an amazing stroke of luck.

The Union army had captured a set of plans that outlined the Confederates routes of march, their strength, and their dispositions. McClellan had the information that would allow him to annihilate the Rebel forces, and, possibly, end the war. But he dithered, throwing away his powerful advantage, and then froze at the battle of Antietam, where the Confederates could have been mauled. The Confederate battle plans should have given him an enormous victory, but the contradictory information flowing in from his intelligence-about enemy hnes of march, strength, and objectives-paralyzed him. The winning strategy was in the Generals hands, but he was psychologically incapable of executing it.

An important aspect of this book, then, is investor psychology. The strategies by themselves are not dissimilar to McClellans situation after capturing the Confederate battle plans. In the marketplace, we too face anxiety, an enormous amount of uncertainty, market noise, and severe consequences from bad decisions. The strategies do not look nearly as clear-cut under these circumstances. If they dont work for a while, most people, even those with strong convictions, quickly discard them.

Without understanding investor psychology and how it affects us all, contrarian strategies, like Lees captured marching plans, are unlikely to be successfully utilized. This is the reason why most people cannot use these strategies even though they are known to have provided superior results for years.

What I hope to show is that, ahhough the study of investor psychology is still in its early stages, there is a body of research conducted by outstanding psychologists in recent decades, that provides us with pattems of predictable investor errors. These errors are so systematic that the knowledgeable investor can take advantage of them. It is upon this behavior that my contrarian strategies are founded.

The major thesis of this book is that investors overreact to events. Overreaction occurs in most areas of our behavior, from the booing and catcalls of hometown fans if the Chicago Bulls or any other good team loses a few consecutive games, to the loss of China and the subsequent outbreak of McCarthyism. But nowhere can it be demonstrated as clearly as in the marketplace. Under certain well-defined circumstances, investors overreact predictably and systematically. This well-documented discovery has sweeping implications within the fields of finance and economics, as well as in many other areas. It is also the key to improving your investment performance.

The research demonstrates conclusively that people consistently overprice the "best investments," be they growth stocks, initial public offerings, or companies involved in telecommunications. Just as consistently, they unde rice the "worst." The "best" investments are not always exciting domestic stocks. They have been precious metals and collectibles in the 1970s, real estate in the 1980s, or investing in the emerging Asian markets in the past few years.

Similarly, "worst" investments change with investor perceptions. In late 1993, investors disdained pharmaceutical and other health-care stocks. They believed these industries would lose most of their value if the Clinton administration passed its health-care plan. As a result, they dived to lower relative levels than at any time since World War II. Yet over the next few years, they became leading market performers. In 1991 and 1992, many computer issues were thought to be poor investments. Subsequently, they led the market for years, many doubling, tripling, even tenfolding.

What our new work shows is that the overvaluation of "best" and the undervaluation of "worst" stocks often goes to extremes-so much sp that eamings and other su rises affect "best" and "worst" stocks in a diametrically different way. Chapter 6 will show you the new, well-documented conclusions that all su rises, both good and bad, bode well for out-of-favor stocks, but bode ill for favorites. Since su rises are a way of life in the marketplace, this knowledge will be a potent tool in our new investment strategies.

The overreaction theory, although revolutionary, is elegant in its simphcity. People, as chapter 11 demonstrates conclusively, are consistently

too optimistic about stocks that appear to have good prospects and too pessimistic about those having so-so outlooks. Investor overreaction underlies and supports the new investment methods that will be outlined in this book. The strategies we will examine based on this theory can dramatically increase your odds in the marketplace.

My approach will try to accomplish two major functions. Before all else, a successful strategy requires a strong defense: it must preserve your capital. The strategies herein are designed to protect investors from powerful emotional pitfalls. After defense, we need a powerful offense. We achieve this by taking advantage of consistent mistakes made in markets because of predictable behavior pattems. Both parts of the strategies rely on an understanding of investor psychology.

The new work in psychology explains why people in markets often behave like crowds at a theater fire. In one age the rage was tulips, in another collectibles, in another stocks or real estate-but at any moment, most investors rush for the same door at once, and many get trampled.

The bottom line of these methods is, of course, to make money. The strategies we will study are down-to-earth, disciplined, and-most important-have proven successful. Using the approach and the new tools I will outline, you should be able to enhance your investment performance.

No investment strategy should be followed blindly, and a good part of this work is devoted to explaining why my methods work. The ideas, although not complicated, require an understanding of investor psychology and the discipline to carry it through. When you understand them, you can avoid the mistakes of both the markets pros and its "patent medicine men." Both the theory and the methods, then, are simple. But you will still have to avoid some tricky psychological pitfalls, especially in crisis. Knowing these principles wont make it a Cakewalk. It is hard to stay unaffected by psychological pressures, as Ive too often found in free-falling markets. No matter how often youve been there or how much youve read, you cant escape the fear. But as chapter 12 will demonstrate, you can still act on and profit from the situation.

A number of key chapters cover other important aspects of investor psychology that are essential to successfully utilizing these strategies. Chapters 4 and 5 look at the advice of the investment expert in contemporary markets, and how it almost inevitably works against the investor. Chapter 10 examines the cognitive errors we all make as investors, and how we can avoid many of them, while chapter 16 analyzes the powerful influence of group and peer pressures on people. These often shape incorrect views on the outlook for the market or individual stocks.

The psychology is well documented and leads to a number of decisional safeguards, which I have listed as Rules, that if followed, can