How to Buy, Manage Risk, and Keep Records

Masses of traders crowd into the markets, looking for profits. Every serious trader knows he needs an edge—a method of discovering opportunities and placing orders that gives him an advantage over the majority of competitors. A slight edge, coupled with a lot of discipline, is the key to steady profits. Every professional knows what his edge is and where the profits are likely to come from. A beginner does not bother himself with such concepts. He may buy today because last night he read about an inverted head-and-shoulder bottom. He may buy tomorrow because of a piece of news that caught his attention. He has no clear concept of buying. He has no edge.

We all go through this stage of initial ignorance. To move beyond it and graduate to trading for a living you need to have a concept of what it is you are trying to buy or sell.

If you find a money-making niche, others may soon crowd into it and drive down the returns. Your profits are always under threat, while the dangers are ever-present. The competition is intense. To keep making money in the markets and to grow equity, you need to define and implement a trading concept that is fairly simple and bulletproof.


My long search for an edge led me to study the gap between price and value. The concept is quite simple: price and value are not the same. Price can be below value, above it, or equal to it. The distance between price and value may be large or small, increasing or decreasing at any given time. Surprisingly few people are aware of the ever-changing gap between price and value, although when you point it out to them they see it immediately.

The concept is simple, but turning it into a trading method is not that easy.

Everybody knows about price—you read the numbers on a price tag or look up a stock quote on the screen. Any child can tell you the price of candy. We all know price, yet very few people know how to define value and track its changes. If you can do that, your buy or sell decisions are no longer based on price alone. You can buy when value is rising or sell short when price gets too far above value.

Most buying decisions are based on the perception, however vague, that price is below value. Most people buy when they think the crowd does not recognize the true value of their trading vehicle. They think they see ahead of the crowd, and expect to make money after the crowd also sees what they do and drives prices higher. Traders buy when they think that some future event will cause an increase in the value of their trading vehicle.

I became aware of the gap between price and value decades ago, during a brief lecture by J. Peter Steidlmayer. Listening to this Chicago floor trader and sometime author I immediately sensed the value of the concept. I had no idea at the time how many years I would spend looking for a way to implement it in my trading.

Few technical traders ever think about the difference between price and value. Fundamental analysts are much more attuned to the idea, but they do not own it—technicians can use it as well.

It makes sense to buy below value and sell above value. To implement this idea, we need to answer three questions—how to define value, how to track its changes, and how to measure the distance from price to value.

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