The Mental Strategies of Top Traders: The Psychological Determinants of Trading Success

4.8. 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, ...