Trading, Value Investing

Premises of Investment and Trading Strategies

There are many ways to make money (and lose money) in the markets. I wanted to summarize the big buckets of investment / trading strategies out there, their premises (i.e. their underlying thinking about the markets) which drive how various people approach the markets. It is not always the case that the strategy one uses falls cleanly into one of the buckets below, for example one can be looking at global macro but apply value investing in choosing specific stocks. Nonetheless, I think most people would usually fall into one of the buckets below based on their view of the markets.

I would have preferred to put the information below into a nice table, but it’s not that straightforward it seems for blogs.


Basic Premise

  • Fundamentals drive prices.
  • In the short run, the market is a voting machine but in the long run, it is a weighing machine.

Value Investing

  • Premise
    • Price is what you pay, value is what you get
    • Estimate the value, discount that value to get a “margin of safety”, buy if you have a margin of safety, sell when fully valued
  • Examples
    • Warren Buffett, Seth Klarman, David Einhorn

Global Macro

  • Premise
    • Macroeconomic fundamentals drive the markets
    • Follow macroeconomic variables and use that to predict how the markets will move based on your macroeconomic model
  • Examples
    • Ray Dalio, George Soros, Paul Tudor Jones

Merger Arbitrage / Spin-offs / Restructuring

  • Premise
    • Market does not price deals correctly because few people actually plow through the ton of documentation to figure out the proper value of the assets after special corporate situations.
    • Hence by digging in deep and analyzing each special situation, we can take advantage of market inefficiencies
  • Examples
    • Joel Greenblatt, Warren Buffett

Distressed Vulture Investing

  • Premise
    • Buy assets at fire-sale prices and restructure the company and/or work through the bankruptcy process to realize their value
  • Examples
    • Martin Whitman, Paul Singer


Basic Premise

  • There are always positive and negative ways to interpret data, hence there is no point listening to news, economic data, opinions, etc.
  • Everything you need to know is reflected in price and volume.

Trend Following

  • Premise
    • Big money is made when a market trends. The market can go to extremes due to behavioral biases.
    • Ride your winners, cut your losers.
    • Keep trying to catch trends, one good trend pays for all the many small losses.
  • Examples
    • Ed Seykota, William Eckhardt, Bill Dunn

Range Trading

  • Premise
    • Markets range most of the time (~75%)
    • Short at resistance, buy at support
    • Take many small consistent gains, and occasional big loss when a market trends.
  • Examples
    • Dighton Capital


Basic Premise

  • Rely on history as a guide.

Growth Stocks Trading

  • Premise
    • Historically, biggest stock market winners have been high growth stocks in new industries with similar characteristics
    • Look for the stocks with the same characteristics (e.g. can be both fundamentals and technicals).
  • Examples
    • IBD CANSLIM, Nicolas Darvas

Situation Matching / Pattern Recognition

  • Premise
    • Look in history for all instances of market situations similar to the current situation, and compile what the market did previously to use that to forecast what the market will do now.
    • E.g. market has fallen 8 days in a row. Look for all instances in the past where the market has fallen 8 days in a row, in what % of the time did the market go up, down, sideways, over what time frame, by how much, etc. Then use the data to take “high probability trades”
  • Examples


Basic Premise

  • Focus on the market book and trades at the immediate moment to look for opportunities

Market Making

  • Premise
    • Provide liquidity, make the bid-ask spread
    • Adjust your bid-ask spread accordingly to your assessed price of risk
  • Examples
    • Knight Capital Group, Getco Securities, Virtu Financial


  • Premise
    • Take short-term (seconds and below) directional trades at high probability moments / locations.
    • Relies on reading the market depth and the tape (time & sales) to understand short-term demand and supply
  • Examples
    • Paul Rotter (aka “The Flipper”)


Basic Premise

  • Use statistics / mathematics to model statistically significant relationships

Statistical Arbitrage / Spread Trading

  • Premise
    • Build statistical models of relationships among various asset prices, and take positions when prices are out-of-whack according to the model, to profit from the likelihood that prices will revert back to the relationship specified by the models.
  • Examples
    • Peter Muller (Morgan Stanley’s Process Driven Trading unit), Jump Trading

Long / Short (Market Neutral) Trading

  • Premise
    • Long strong stocks, and short weak stocks, to offset the market return component (i.e. beta) and isolate alpha
    • With the lower volatility, take on leverage to juice up the returns
  • Examples
    • Anton Kreil

Cycles Trading

  • Premise
    • Stock prices are a composition of many different cycles of various frequencies, amplitudes, etc.
    • Use mathematics to decompose prices into its underlying cycles, and use that to forecast future prices.
  • Examples
    • Walter Bressert


Basic Premise

  • Buy and sell the same thing at different prices and make the difference.

Index Arbitrage / Program Trading

  • Premise
    • Buy the index (futures), short the index constituents (cash market) or vice versa, when their values are deviate too much

Cross-exchange Arbitrage

  • Premise
    • Buy and sell the same contract across different exchanges, when there are temporary price differences
  • Examples
    • Arbitraging Nikkei among CME, OSE, SGX


Basic Premise

  • Too difficult to forecast the markets so don’t even try.

Index Investing

  • Premise
    • Stocks have historically returned ~10% over the long term, so just buy stock index funds
  • Examples
    • Advocated by Warren Buffett, John Bogle, Jeremy Siegel

Invest in Treasuries

  • Premise
    • Stock returns  are too uncertain to meet specific cash flow needs (e.g. retirement, kids’ education)
    • Best way is to invest in TIPS, bonds.
  • Examples
    • Zvi Bodie

Lazy Portfolios

  • Premise
    • Too difficult to forecast the markets, buy a mix of asset classes so that the portfolio does decently in various economic conditions
  • Examples
    • Permanent Portfolio, Perfect Portfolio, Coffeehouse Portfolio, Gone Fishin’ Portfolio



2 thoughts on “Premises of Investment and Trading Strategies

  1. Reblogged this on Musa's Blog and commented:
    Very well written and I am sure many readers will relate to it. So, which group / category / approach do you belong to?

    Posted by Musa Kaiser | November 11, 2014, 2:49 pm


  1. Pingback: Nassim Taleb vs. Victor Niederhoffer | Journeys of a Bumbling Trader - December 6, 2015

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