How to think about Market Prices Part 1: Mr Market

Friday, Feb 03 2012 by
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How to think about Market Prices Part 1  Mr Market

From 1981 until very recently the key strategy of equity investors was 'buy and hold'. It just worked. From a very low base the valuations of equities rose and rose, fuelled by falling interest rates, a wave of cheap credit and an investment boom in technology companies. Those conditions were ripe for a bull market to prosper but perhaps not to the nosebleed PE multiples that were seen at the top. Perhaps naively investors have been hoping for such a bull run ever since, but the current reality is very different from those anomalous conditions bearing some resemblance to the kinds of markets witnessed earlier in the last century, an era in which the guru of the market was Benjamin Graham.

Graham, tutor of Warren Buffett and father of value investing, lived through some of the most turbulent bull and bear cycles in market history. It was in this environment that he forged his investing philosophy by shunning vulnerable high multiple growth stocks in favour of the many more asset backed bargain investments he found available. But one of his key insights was in the behaviour of market prices, insights that he wrote about in Chapter 8 of his famous book for the layman '*The Intelligent Investor*'. It is this chapter with its famous parable of 'Mr Market' that Warren Buffett has long referred to as being one of the most profitable readings any stock market investor can make.

Market Fluctuations and Portfolio Management

Graham starts by discussing the two ways an investor can profit from market fluctuations - by either the way of 'pricing' (buying stocks below fair value and selling above) or the way of timing (anticipating future price movements). He makes it very clear that the way to 'satisfactory results' is the former rather than the latter - "if he places his emphasis on timing he will end up as a speculator with a speculators results". This belief echoes modern research into the folly of forecasting that shows most stockbrokers have no insight at all into the future course of price movements - in fact quite the reverse.  

But Graham does say that on occasion one can profit from market timing but only after price movements have occurred not before. But while certain volatile market environments work well for this strategy of 'buying low, selling high', others such as the bull markets…

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1 Comment on this Article show/hide all

anahin 8th Feb '12 1 of 1

The nice thing about the neurotic Mr Market is that he's always willing to buy or sell at the same price.
Which is always different from the his previous price.

You need to decide whether you should buy or sell, based on his price.

Profit from his folly, rather than participate in it - as Buffett said.

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About Edward Croft

Edward Croft

CEO at Stockopedia where I weave code, prose and investing strategies to help investors beat the stock markets. I've a background in the City and asset management but now am more interested in building great stock selection tools for the use of investors online.   Traditionally investors online have had very poor access to the best statistics, analytics and strategies for the stock market and our aim is to set that straight.  High Quality fundamental information has been prohibitively expensive in the past and often annoyingly dull. People these days don't just want to know the PE Ratio and look at a balance sheet. They expect a layer of interpretation over data, signal from noise and the ability to know at a glance whether a stock is worth investigating or not. All this is possible using great design and the insights gleaned from quantitative research.  Stockopedia is where we try to make it happen ! more »

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