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Trading Momentum & Trading ValueValue Investing,Value investing is a method of investing derived from the ideas of two Columbia Business School professors, Benjamin Graham and David Dodd. The best known advocate of the value investing philosophy is probably Warren Buffet. Warren Buffet took the concept of buying when the market price of a company falls considerably below its intrinsic value further than Graham and Dodd and summed up his new philosophy with one of his best known quotes: "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." Valuing investing can be summed up as buying when the price (as measured by it's market capitalisation) falls significantly below what you reasonably believe the company's intrinsic value to be and then holding on to that investment – Benjamin Graham called the difference between a company's intrinsic value and its price the "margin of safety". A company's intrinsic value is usually based on the future profits that the company can reasonably expected to generate. Of course, it is impossible to know for sure exactly how much profit any company can be expected to earn in the future, so future expectations are usually heavily based on the companies performance in the past, with other fundamentals such as value of the companies net cash balance, tangible assets and liabilities also taken into account. A company's market capitalisation to its earnings is usually expressed as its Price to Earnings Ratio (P/E Ratio) and as a very general rule, when a company can be bought for less than 10 times it yearly profits its shares are considered cheap. Buying profitable companies cheap is what is called value investing or buying value. Trading Momentum,Momentum is simply the rate at which price changes and when the price of a share is rapidly increasing speculators often buy it in the hope that the momentum will continue and the companies shares will continue to increase in price. Traders who trade momentum usually care very little about a company's earnings, balance sheet, dividend payments or any of the other economic fundamentals; they simply buy when the share price is rapidly rising with the aim of selling as soon as the price momentum slows down or stops. Value Investing Vs. Trading Momentum,Value investing differs from trading momentum in almost every way. Firstly, value investors usually invest for the long-term, while traders that trade momentum will usually not hold trades for very long at all. Momentum trading strategies will typically demand that the trader ditch a trade the moment the market price shows any signs that it's no longer moving in their favour. Secondly, value investing is based on economic fundamentals such as price to earnings, the value of the company's tangible assets minus its debts and liabilities, the net cash position on the balance sheet etc... Momentum trading strategies however are based purely on technical analysis (i.e. price changes divided by time) and fundamentals are not even taken into consideration. Also, traders that use momentum trading strategies to trade shares are almost always seeking to profit from an immediate capital appreciation and they don't usually care about things like dividend payments or the company's future potential. And lastly, the thing that really sets value investing apart from momentum trading strategies is the fact that trading using momentum is pure speculation and value investing is just that: an investment strategy and not a speculative gamble. The difference between investing and speculation is how one intends to profit from the asset in question. Speculators typically buy assets to profit from the asset increasing in price whilst true investors buy revenue generating assets in order to profit from the returns that the asset itself can yield. In the case of equities, true investors buy companies to profit from the company's earnings as earnings are either paid out to the shareholders in the form of dividends or reinvested in the company (which the investor owns) in order to create even more profits. Oddly enough, in the UK at least, it is investors and not speculators that are penalised most heavily by the Inland Revenue. In the UK investors are penalised by a 0.5% financial transaction tax which is payable whenever one buys shares, all dividend payments received are currently taxed at either 10%, 32.5% or 42.5% depending on the investors level of income, and any profits made on shares when they are sold may of course be subject to capital gains tax (currently set at either 18% or 28% depending on the investor's level of income and the value of the capital gains). Speculators in the UK however can bet tax free on the prices of individual shares, market indices, commodities, the Forex market and other financial markets using financial spread betting. If a speculator chooses to trade using CFDs (Contracts For Difference) instead of financial spread betting their gains may be subject to capital gains tax but there is no financial transaction tax on trading CFDs in the UK at this time as far as I am aware. |
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