An Introduction To Different Ways To Invest
There are two major investment styles which take completely different approaches. They are value investing and momentum investing. The former, also known as contrarianism, seeks to find cheap assets to buy. It is called contrarianism because often it involves looking for assets which are cheap because no one likes them. Momentum investing is simpler. This simply observes that often, assets that have been performing well continue to do so. So investors adopting this style just look for assets which have gone up and hope that they will continue to do so.
I favour value investing. One reason for this is because the problem with momentum investing is that assets which have done well continue to so until they don’t. There is no way to tell when something which has gone up will stop doing so. And we definitely know that nothing will appreciate forever!
The difficulty with value investing is knowing when an asset is cheap. In the early days of investing, the concept of book value was very useful. This is simply the accounting value. If a company owns a factory and some machinery, the book value will be close to the value for which the factory and the machines could be sold. If you can buy a share, or a slice of the company, for less than the book value per share, you should.
Book value is still very useful on many occasions. But modern companies are very complicated, and often much of what they do cannot be valued simply. A lot of their worth might be tied up in software, for example, which is harder to value than a building. Or they might own a lot of IPR — intellectual property which again, is intangible and hard to value. But the effort is worth it. Finding a cheap company to buy is one of the best ways to trade successfully.
I have written a lot about the importance of psychological factors in investing. It is absolutely crucial that you understand these, for two reasons. Knowing about your own psychology will help you understand and improve your decision-making processes. It will be especially valuable to know when cognitive biases are likely to cause you to make errors in evaluating investments. But just as important is knowing how other investors will think — after all, they have the same psychology as you do! And knowing what other investors are likely to think of an asset is the key. Because you want to find an asset which is not just cheap — but unjustifiably so. Then you can expect it to go up sustainably.