Sunday, 9th April 2017

What is your advantage?

Written by George Traganidas Topics: Habits, Stock Investing, Wealth Building


Investing is a zero sum game. For each investor that is buying a security because he thinks that it is undervalued, another investor is selling the same security because she thinks that it is overvalued. This difference in opinion is what makes the market. If everyone wants to buy or sell the same security at the same time, there would be no one to take the other side of the trade and there would be no market.

Therefore, the most important concern for an investor is to consider who is at the other side of the trade. In order to make money, the investor must be looking to trade in securities that they have an advantage over the other person. If the investor cannot identify what is their advantage on a particular trade then chances are that they do not have one and the other person might have it. The advantages that an investor can have generally fall in one of the following categories.

Certain investors can have an Information Advantage. That means that the investor has more or better information about the security than the other person. This used to be a huge advantage for certain investors before the internet age, because they could access information that other people could not. In this age though, this advantage is very hard to have, because the internet has democratised information and almost everyone has the same information. These days, investors are trying to gain this advantage by speaking with company management or buying proprietary research. The search for information advantage is so competitive that for example some investors even go as far as using satellite imaging to check car parks of retailers in order to predict future sales. The investor must take a lot of care to distinguish between public and non-public information. Trying to use non-public material information as an advantage is illegal in many countries. In addition, many times the line between public and non-public information is grey.

Certain investors can have an Analytical Advantage. These investors have a more sophisticated way of analysing the information that is available to everyone. They depend on computers and clever algorithms to better analyse public information. In this age, where most of the people have access to computers this advantage is also hard to possess and maintain. Investment companies employ maths and physics PhD graduates to build ever more sophisticated analytical models in order to try to gain an edge. An investor needs to take into account that some company data cannot be accurately known (e.g. how much are the customer relations really worth) and therefore even the best analysis has to use estimates and deal with incomplete information.

Certain investors can have a Time to Market Advantage. These investors are trying to beat other investors in getting their order executed in the market. They do not rely on selecting specific securities to buy as long as they can get to buy the securities a few milliseconds before other investors and they can then sell these securities to them for a tiny profit. This is a form of ‘front-running’. In order to gain this advantage, certain investors install computer in the exchange buildings, so their buy and sell instructions have to travel a few millisecond less to be executed.

Certain investors can have a Time Horizon Advantage. Investors buy and are willing to keep securities for a certain amount of time before they sell. Some investors hold them just for a few days and others for years. Holding the securities of a well-run company that can compound returns for a long time can be an advantage against the people who buy in and out of the stock, because the company becomes more valuable over time. Some companies make decisions that incur short-term pain and they deliver long-term benefits. An investor who can focus on the long term has an advantage not only because he will reap the long-term benefits but also because he will have lower trading and tax costs.

Certain investors can have a Behaviour/Psychological Advantage. The psychology of the investor plays a very crucial role in the market. The investor must be aware of his biases and his psychology and only buy or sell securities based on logic and analysis and not based on emotions. Many investor fall victims to herd mentality and they base their buy and sell decisions on what the crowd does and not on reason.

Investing in individual securities is a very competitive game that attracts the best minds in the world, because the rewards of winning are so high. Very few people win consistently over the long term but the siren’s song is very hard to resist. Some investors know about the difficulty of the game and they decide to invest in index funds instead. Admitting that they do not have an advantage in the game and deciding to use index funds instead is an advantage of itself.

Follow the practical way,

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