Give Yourself an Edge

It is critical that you identify your edge when purchasing a stock. Assume that the person on the other side of the trade is smart and well informed. If you can’t identify your edge and the other party‚Äôs reason for selling you may be the patsy in the transaction.

Buying when others are fearful is one of the best ways to do this. When there is a lot of fear in the market and people are dumping stocks, it is far more likely that sellers are not acting on an informational advantage. They are probably selling for reasons that have nothing to do with value, i.e. they are afraid, they need to raise capital for redemptions or because a security no longer meets their investment policies.

Caution! Just because there is fear in the market is not a sufficient reason to buy a stock. The company must still be selling at a discount to a conservative estimate of intrinsic value. Without an estimate of intrinsic value you may still be purchasing an overvalued company. Buffett suggests writing down your reason for buying a given stock prior to making a purchase. It you can’t state in simple terms why a stock is a bargain, you should not buy it.

There are other ways to gain an edge, but this is one of the best. It is more a function of temperament than superior insight or analytical ability. Simply putting this discipline into practice should improve your results.

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