Introduction

To survive and profit in financial market trading in the long run, it is necessary to achieve a more accurate pricing of the risk-return ratio than the market and then trade based on the risk-return ratio. The so-called "pricing" often only pursues fuzzy correctness, and obsessing over precise pricing only wastes time on finding errors. Specifically, at the trading level, a profitable trade requires a fuzzy and correct answer to the following three questions:

1. Do I have a correct understanding of the target asset?
2. Does the market have a mistaken understanding of the target asset?
3. How long will the market take to correct its mistakes, and can my position survive?

The cognitive differences between questions one and two lead to differences in pricing of the investment target. These pricing differences can infer potential profits and risks, namely the Risk Return ratio, which is the essence of an excellent investor's or trader's alpha source. Question three can be used to measure whether the return on investment during a certain time period meets personal pursuit, as well as to assist in improving position survival ability. The first two questions are the key issues that require the most researchs investment in trading. Answering these two questions is extremely difficult in most fields, and even investing years of effort in learning and expanding one's circle of competence may not lead to a clear answer. Therefore, it is wisdom to recognize the limitations of one's own knowledge and give up on certain topics.

Do I have a correct understanding of the target asset?

When we talk about "correct understanding," we are actually pursuing the future free cash flow growth of the investment target, but in reality, the target asset can only obtain more free cash flow from the world if it has better bargaining power (same as individuals). To understand bargaining power (and its changes), we need a deep understanding of specific business, competition, and human nature.

• Do we have have true and comprehensive information? Or at least fair information situation?
  • First, judge the information asymmetry before discussing the correct understanding: it is difficult to gain an advantage in understanding when there is a significant gap in information quality.
  • How to judge our position in information acquisition? When communicating with other investors with pricing power, most of the factual information is already known.
• Two underlying elements to achieve a correct understanding: continuous learning (changing world) and respect for human nature (unchanging things).
• Does the understanding respect common sense, human nature, and business logic?
• Constantly consider one's own limitations and think from the opposite perspective of one's own views.

Does the market have a mistaken understanding of the target asset?

The main purpose of understanding the market is to identify the core factors that affect the price. When the market trades on a wrong view, we hold the opposite correct view, and the market eventually corrects its mistake to achieve investment alpha.

Where to get market information?

• Consider the authenticity of market information, as higher-cost information typically has higher authenticity.