The Mental Strategies of Top Traders by Ari Kiev

Author:Ari Kiev
Language: eng
Format: epub
Publisher: Wiley
Published: 2010-05-10T16:00:00+00:00

CASE STUDY ON KNOWING THE BUSINESS

I discussed these themes with Alex, a brilliant portfolio manager who was very specific about the kinds of questions to consider when looking for a differentiated view from what others in the marketplace had developed and the kinds of considerations that were critical in determining whether there was indeed enough evidence to support further time and effort in investing in a particular idea.

Kiev: Can you expand on the kinds of work necessary to determine whether it is worth pursuing research in a particular idea? What do you think about before you begin digging in with traditional fundamental research?

Alex: The expectational gap is essentially the gap between the expectations that are being applied by the marketplace and what you perceive. The larger that expectational gap, and the better you can define what that expectational gap is, the greater the magnitude of what you’ll get paid if you close that gap.

So, recognizing something is cheap or recognizing that something looks like a good investment isn’t even close to enough. You have to articulate clearly why it’s priced here and what has gotten it here. What specifically is the misunderstanding, and why do you think you’re different? Then, how is it going to close?

This doesn’t mean that if there is no expectational gap the idea won’t work. It just means that the probability of getting paid for being correct is random. There are a lot of instances where we actually miss good investments, where there is no expectational gap.

I think for ideas that have greater than three-year time horizons, the concept of expectational analysis is much less relevant because the true fundamentals of the business will determine after three years what it is.

People have a natural tendency to think they’re the first to know something. They actually don’t think about how many other people have combed over this idea. What we really try to encourage and teach is this extremely high level of skepticism on what you are observing and sort of where you are when you are observing it.

K: Could you talk a bit about the process and the work techniques that you have learned that can decrease the time you need to spend on a phone with an analyst to measure what’s changed or where the buildup is?

A: There seems to be this misconception in finance that the more work you do the more likely you are to make money in a stock. In some cases, this is true. In a lot of cases, it’s not only wrong, it’s actually worse because you become overconfident. You do an excessive amount of work, and you think you understand everything about the company, but you actually don’t know a lot about the stock.

I sort of set out to build a new model that was predicated on efficiency and velocity and identifying the gating factors in an investment idea first. So, in some of our largest positions we had as much work done as any analyst or team for that name if we have a giant position.

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