I came across this article from "http://aswathdamodaran.blogspot.sg/2013/10/twitter-ipo-why-good-trade-be-bad.html"
Previously I have written a brief description on Investors VS Traders . It is a general description to help my clients to understand which sort of market players they are.
And as Damodaran mentioned, there is no right or wrong if you are an investor or a trader. It depends on your character and preference.
Afterall, we enter the market to make money, don't we?
Previously I have written a brief description on Investors VS Traders . It is a general description to help my clients to understand which sort of market players they are.
And as Damodaran mentioned, there is no right or wrong if you are an investor or a trader. It depends on your character and preference.
Afterall, we enter the market to make money, don't we?
The Pricing Game versus The Value Game
The Pricing Game
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The Value Game
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Underlying philosophy
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The price is the only real number that you can act on. No one knows what the value of an asset is and estimating it is of little use.
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Every asset has a fair or true value. You can estimate that value, albeit with error, and price has to converge on value (eventually).
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To play the game
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You try to guess which direction the price will move in the next period(s) and trade ahead of the movement. To win the game, you have to be right more often than wrong about direction and to exit before the winds shift.
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You try to estimate the value of an asset, and if it is under(over) value, you buy (sell) the asset. To win the game, you have to be right about value (for the most part) and the market price has to move to that value
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Key drivers
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Price is determined by demand & supply, which in turn are affected by mood and momentum.
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Value is determined by cash flows, growth and risk.
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Information effect
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Incremental information (news, stories, rumors) that shifts the mood will move the price, even if it has no real consequences for long term value.
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Only information that alter cash flows, growth and risk in a material way can affect value.
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Tools of the game
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1. Technical indicators
2. Price charts
3. Multiples & Comparables
4. Investor psychology
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1. Ratio analysis
2. DCF valuation
3. Excess Return models
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Time horizon
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Can be very short term (minutes) to mildly short term (weeks, months).
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Long term
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Key skill
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Be able to gauge market mood/momentum shifts earlier than the rest of the market.
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Be able to “value” assets, given uncertainty.
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Key personality traits
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1. Market amnesia
2. Quick acting
3. Gambling instincts
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1. Faith in “value”
2. Patience
3. Immunity from peer pressure
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Biggest Danger(s)
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Momentum shifts can occur quickly, wiping out months of profits in a few hours.
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The price may not converge on value, even if your value is “right”.
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Capacity to move prices (with lots of money and lots of followers).
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Can provide the catalyst that can move price to value.
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Most Delusional Player
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A trader who thinks he is trading based on value.
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A value investor who thinks he can reason with markets.
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"
If you play the pricing game, you are a trader, and if you play the value game, you are an investor. I am not passing judgment, when I make this statement, because unlike some value investors, I don’t view traders as shallow or somehow less critical to the functioning of markets than investors. After all, a trader who makes a million dollar profit can buy just as much with that money as an investor who makes the same profit. Ultimately, which avatar (price or value) best fits you will depend not only on your level of comfort with the tools (Are you better at reading charts or valuing companies?) but also on your personal traits. In my experience, naturally impatient people who are easily swayed by peer pressure almost never succeed as value players and excessively cerebral folks who have to weigh everything in the balance, before they make decisions, are incapable of being traders.
This black and white view of the world may strike as some of you as extreme. After all, why not allow for shades of grey, traders who are interested in value and investors who think about the pricing process? While I will dive into this netherworld in future posts, I will not in this one, for two reasons. The first is that many of self-proclaimed hybrid investors are nothing of that sort. There are traders who pay just lip service to value, while using it back their momentum plays and investors who claim to respect markets but only until they start moving in the wrong direction. The second is that there is a danger in playing on unfamiliar turf: traders who delude themselves into believing that they understand value can undercut their own effectiveness just as much as investors who think that they can get in and out of markets, when it suits them. A healthy market needs both traders and investors, in the right balance. A market that has no traders and all investors will have no liquidity and one that has all traders and no investors will have no center of gravity. Ironically, each group needs the other for sustenance. Trading and momentum cause prices to move away from value, creating the bargains that investors try to exploit, and in the process of exploiting them, they create the corrections and momentum shifts that other traders exploit.
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