When you are considering a stock to trade, you have to view yourself
as a doctor treating a patient. You have three points of view to help
you in your diagnosis:
1. The patient’s general condition: age, gender, any preexisting conditions,
regular exercise or not, smoking or heavy drinking, and so on.
2. The patient’s symptoms: pain, fever, swelling, and the like.
3. The patient’s internal examination: a blood test, a scan, an X-ray, and
so on.
When analyzing a stock, you may think that the general condition is the
fundamental analysis: earnings, profit growth, and so on. It may disappoint
you to learn that these are only external measures of value. Value itself
is useless if not compared to how it is priced. How value is priced is also
virtually useless if you do not know what the expectation of shareholders
is. Indeed, being a shareholder means possessing equity (value) for which
the shareholder expects a return.
You will understand in Chapter 2 that the general condition of a stock
is partly represented by its price trend. You will often see a price moving
above and then below its price trend, indicating the evolving perception
of value. Good trading requires you to catch this perception of
value. I translate it into the measure of the expectation of active traders.
You need to position your trades in harmony with this expectation: