Updated on 5-16-2010. An older version may be found here.
What is a stock market philosophy?
As I use the term, a stock market philosophy is a person's evolving perspective and approach to the stock market. Highly personal, and quite subjective. Everyone has one, whether they trade or not, but if they are traders, then their market philosophy is the basis for developing and applying a trade strategy. As a trader, and someone with a vested interest in what happens in the stock market, I like to think that mine is at least somewhat relevant and in line with reality. As I find where and where it isn't a good match with reality (e.g., when I am losing money), I adjust it.
Before I started actively trading, I spent quite a bit of time thinking about how the market works, and how I could subsequently capitalize on it. My philosophy has changed a lot since then. Here are what I think are the important parts (nothing new - but concise and my own):
The stock market is an incredibly efficient economy
Meaning, as a general rule, and over some length of time, the price of a stock perfectly reflects what market participants think it is worth.
The stock market is not a perfect economy
However efficient, there is still some delay (or friction) in the spread of information and subsequent delay between what most of the market thinks a stock is worth and what it is currently trading for. The delay between what everyone thinks a stock is worth and the value of what it is currently trading at represents an opportunity for the savvy trader to make money.
Value is subjective - no single method or trader makes the rules
People don't all agree on how to properly value a stock, and if we did, the basis for valuation would rapidly change - some of us would try to anticipate what everyone else is doing and cash in; by necessity causing someone else to not profit as they expected, eventually leading to a change in the valuation basis.
The market is never wrong
That is to say, the majority market opinion is what drives longer term stock price.
Market participants are human
And more or less like me. Common characteristics include (in no particular order):
- Some people want to make money in the short term
- People use multiple (and sometimes difficult or impossible to quantify) criteria to determine when to trade a particular stock. A lot of times, trading decisions are based on nothing more than a person's emotions.
- Some people are constantly adapting, refining, or re-vamping our approach to the market - i.e., what we think works or doesn't work
- People are what make short term price action interesting, incredibly difficult to understand, predict, and/or explain.
Conclusion:
Plenty of things to talk about here. A personal market philosophy is the foundation for a personal trading strategy - I would encrouage new traders to spend some time thinking about how they think things work, what is important, and what is not. And make it your own. If you take the time, I think you will see a lot of what I have outlined evident in my overall entry and exit strategies.
.
