A Perfect Contrarian Trade For Christmas

There is very little I love more than a contrarian trade with a great risk/reward ratio. There is something satisfying about opposing conventional wisdom and being right, and when you can do so while risking minimal losses, it always grabs my attention. That is why I am looking at a trade in the ever so unpopular, beaten-down lithium industry.

The long-term case for lithium stocks is obvious and hard to refute. Lithium-ion batteries have emerged as the clear winners in the battle to power EVs and, with that market set to explode before too long, demand for lithium will explode with it. The problem in the second half of this year, however, has been that, as usually happens when a trade is obvious and well-publicized, any value in lithium stocks disappeared as the hype mounted. Once they started to soar, it wasn’t long before momentum pushed them to the point where a correction was inevitable. That correction duly came last month, but now it is starting to look as if that correction itself is overdone. One lithium stock, in particular, looks worth nibbling at as it approaches an important support level.

Livent Corporation (LTHM) is a pure-play, American lithium company that was spun off from a general mining company in 2018. It crossed above the $22 level (blue line on the chart above) for the first time in August and, once it did, that became a support level that was tested multiple times before the stock really took off in October. As I said, though, the enthusiasm for the stock was a bit overdone, and a pullback was coming. It came, and now that we are close enough to that $22 support to make it a viable level off which to set a stop, it looks like a good time to buy.

The chart, however, wasn’t the only thing that makes me think the drop may be nearly over. There are currently a lot of articles like this around, telling you that you should be selling LTHM. It points to current valuation metrics that have nothing to do with the prospects for the industry as a reason to take a trade that would have been a great idea six weeks ago, but that has now played out. Momentum-based analysts who cherry-pick data were, in a lot of cases, the ones telling you should have been buying just before the top so, if you will forgive my cynicism, the fact that they are now telling you to sell suggests to me that we are close to the bottom.

Of course, for a long-term trade like this, the contraindicator of a momentum analyst who comes late to the party and ignores the principal reason that a stock has value can only take you so far. Over the next few months, the attitude of the market towards growth stocks and risk, as well as the long-term prospects of the company, will decide LTHM’s fate. On both fronts, there is enough chance of a positive shift to make buying at these levels a reasonable trade.

Growth stocks and risk are out of vogue right now, as evidenced by the fact that the Nasdaq has led the recent declines in the market. However, these things are always cyclical, and if you look longer-term, small-cap consistently outperforms large-cap, and the Nasdaq consistently outperforms the Dow. Or, to put it another way, growth is king, and risk is rewarded over time.

Still, that inherent volatility has to be considered, which brings us back to the current level. Buying here with a stop at say, $21.70 would risk only around 7% of your initial investment on a trade that, if LTHM just returns to its levels of a couple of weeks ago, would return around 35%.

In reality, nothing about the long-term prospects of LTHM has changed from when the stock was thirty or forty percent above its current level. What has changed is the conventional wisdom around it and other industry stocks but, as any contrarian trader will tell you, that is actually a bullish signal. With a 1:5 risk/reward ratio on a trade right now, it is well worth paying attention to that signal and looking to buy LTHM before the bounce starts.