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

4.7. DEFINING EXPECTATIONAL ANALYSIS

The expectational gap is another way of expressing Steinhardt's concept of variant perception. The objective is to do research that supports a variant perception in terms of where a stock is and where you expect it will be when its full value is realized. In expectational analysis, you are asking what factors will take place in order for a specific stock to go from its current value to what you consider its full value.

The magnitude of the expectational gap is directly proportional to the amount that you actually expect to get paid. The larger the gap between where the price is and where you expect it to be, once value is unlocked, the more profit you can make. The clearer and shorter the event path, the more likely you are to get paid if you are right. The better you can articulate that gap and the more research and tools you can apply to determine the path to getting paid, the more you can expect to make. The key is to be able to determine why the stock is inefficiently priced.

For example, let's say that the Street values a stock at 20, but from your original work, you know that the stock has more value built into it that the Street hasn't yet realized. You think that the stock could reach its full value at 50. That is your variant perception, what you know about the stock that is not yet known by the Street, based on your research, your talks with the company, your understanding of how a catalyst will go, and so forth. So, the critical ...