Advantages to Generate Alpha
In order to generate alpha that beats the market. A participant has to have an edge. I personally like to arrange them into three categories:
• The ability for you to process certain information different than most participants in market and still turn out to be right.
• It could be based on your working or life experience, that enables you to see things from other perspectives.
• The ability to get “outside number” and “inside number” accurately and set two probabilities on a worst financial outcome and a good outcome, apply Kelly’s criterion to construct your portfolio sizing.
- Outside number: Industrial numbers, Total addressable market, demographics, average financial metrics of a sector etc.…
- Inside number: Individual company financial metrics (I prefer to look at outside before inside number to minimize biases.)
• To get a good answer you need to ask the right question. However, to find a right question is more difficult than finding a good answer in investing.
• Determine the intrinsic value of a company.
- A company’s value, which should be its current market cap, is the sum of all the future discounted cash flow.
- A company’s value is determined at the time it is born as a baby, but no one knows it except god. We could analyze the gene of the baby, the character of the baby, and the environment where it depends to grow.
- When the company(baby) grow to certain stage, you got lesser uncertainty, you will roughly know the value of the time when the baby mature.
- I would know Yao Ming is going to be very tall if I saw him when he is still in primary school, I don’t need to know if he’s going to be 192cm or 201.3cm. I just know he is going to be very tall. Likewise, correct rough estimation is better than precisely wrong estimation. Just wait patiently and choose Yao Ming in primary school when you meet one when market is inefficient.
• The key is to get less greedy. The urge to get money as fast as possible destroy alpha.
• One of the main reasons I did not take profit too early or stop loss unnecessary is that my motivation is not all about money but also intellectual satisfaction from beating consensus.
• The ability to minimize biases from changing environment.
- You can’t eliminate biases; it is in our genes.
- Changing our environment is a more effective way.
• “Wonder is the beginning of wisdom” Socrates. Curiosity is the most undervalued quality in investing. If it is big enough:
- the huge amount of research you have to do is enjoyable.
- Learning is not an obligation but rather a lifestyle.
- It will overcome your ego to defend your preconceived notion and instead searching for truths.
- You would deliberately be searching and improve your approaches on things you like, in my case, businesses.
- You don’t have to listen to Tony Robbins’ fearless motivation to get motivated.
• Hate, envy, victim playing etc... would decrease the quality of your decisions. It is not only a moral duty to avoid those at all cost, but also a great way to be less affected by noise (I think that every form of media is almost always a propaganda.)
• Confidence is overvalued in investing. Skepticism, on the other hand, is undervalued
- Imagine the worst investment outcome possible, and reverse engineer the causes. And then avoid the causes.
• It is crucial to understand what advantage you have as an individual investor compare to institutional investor. It is mainly portfolio size.
- Almost all the stocks are liquid to you compare to institutional. It might be a nightmare for them to liquidate their position when something goes wrong, but you might just need few minutes.
- Illiquid stocks to people with a lot of money does not mean it is illiquid to some people with just moderate amount of money.
• The languages you know that allow you to do research in some market more efficiently than other non-local market participants.
• Fishing in where the fishes are.
- US market has less stock than before and more and more smart people trying to squeeze alpha in a smaller pie.
- More mispricing will be appeared in China, Korea, and Singapore markets. Other drawbacks could be neutralized by analytical advantage.
• Volatility = Risk to institutions but if you could reject the non-sense then you might get risk free alpha by taking more volatility.
These are the three advantages. I might add in more points later if I feel like it.