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Mind of a Successful Traderwww.investing-performance.com
Stock trading is VERY risky.
Learn before you trade.
This is not investment advice.
Consult qualified investment professionals.
Do not trade with more than you can afford to lose.
No warranties here, you are on your own.
When you look at stocks long enough, you start to see the huge role that expectations play in stock valuation.
Sure you have supply and demand, sure you have fundamental valuation, but both of these are greatly affected by expectations.
If the market expects great things from the stock, the stock sells at a high price and it is easy for the company to raise money at less expense.
The company prospers from cheap financing and the fundamental value of the company increases - even if at first, the expectation was wrong.
If you hold the stock you are part of the supply.
If you expect the stock to go up, you do not sell.
If you expect it to go down, you are likely to sell.
Conversely, if you are an investor who might buy the stock, you are part of the demand side of the equation. If you think the stock will soon skyrocket and everyone knows this, you buy with both hands, taking all the offers you can find. If you believe nobody knows this, and the stock may decline before rising, you hold off buying. This much is obvious.
Now look at how expectations can be used to affect the fundamental value of the company.
If you are an evil naked short seller, you can hire people to "bash" the stock with slander, pushing the price so low that no matter what the true value of the company could be, the company is unable to finance itself by selling equity and so dies.
In this type of situation, the expectation can exceed the reality and become the reality.
We also have the theory of contrarian investing. This says that if everyone is bullish, sell. If you are a contrarian and everyone is bearish, buy. The contrarian prospers by doing the opposite of expectations. How can this be?
What you actually have to do is to know the underlying value and look at the expectations that are out there and play one against the other. How will their relationship change?
If the stock is undervalued, and all are bearish, can you see expectations shifting to bullish some day?
If the stock is wildly overvalued, no amount of bullish expectation will make it a good investment; in fact it is probably a good short sale.
As the trick in investing is to find the most undervalued stock that will soon become overvalued, I recommend looking through areas others would not touch for overlooked value.
Some stocks may stay undervalued and overlooked forever, so you try to weed them out. You collect all the undervalued stocks and then see if there are factors there that will cause them to gain positive expectations.
If there are such factors, you engage in more research and find the best of these, study the market, and pick your entry strategy.
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John Lux is a former OTC Market Maker, venture capitalist, investment banker and attorney.
Copyright ©John Lux 2011