We don’t trade the markets, we trade our beliefs about the markets. A good quote from Van Tharp. It is very true as we know there are many different investing or trading strategies out there.
Some believe buying low and selling high is the only ironclad way to make money. It doesn’t take a genius to understand that. This would result in investors focusing on valuation – is the price higher or lower than the value?
This group believes in the mean reversion effect – what goes up must come down and what goes down must come up. Hence, they buy low and wait patiently for the rebound to happen. They are known as the value investors.
Some believe buying low and selling high is dangerous, especially during a downtrending market. A stock that has become cheap can go down even more and be cheaper.
This group (the momentum traders) believes in following the price direction and never go against it. They don’t want to buy into weakness. They want to buy into strength. They want to buy high and sell higher.
And that means that most of the time the prices will look high to most people. In fact, breaking an all-time high is a bullish sign to this group. Others believe that a high price is dangerous and is due for a correction – the price collapse can be sudden and of a large magnitude.
How do we reconcile the differences? Is it possible for both strategies to make money? The answer is yes as finance research has proven both value and momentum deliver higher than average returns. Even the same stock can become a value stock at one point and a momentum stock on another occasion.
Mean reversion (value) usually take a few years to happen while momentum happens in the short term – weeks to months. Hence, one is suitable for intermediate timeframe and while the other is for shorter term trading.
The last group believes in buy and hold. They are the growth investors. They believe in compounding effect and a company that can continue to grow will be able to compound its value over time. Hence, why sell when you can ride it all the way to tremendous return?
The key is to ensure the company has sustainable competitive advantage to defend or even grow its market share over time.
The naysayers believe that it is not easy to predict the future growth trajectory of a company. More often than not the extrapolation of growth is wrong and only realising it 10 years later would incur great opportunity cost.
I have covered 3 strategies but there are more. It is important to note that there is no flawless strategy as each has its pros and cons.
What is your belief?