[David Sklansky]

1. As already discussed, look at companies without knowing their stock price, use your fundamental analysis skill to estimate the fair price of the stock. And consider buying or shorting if there is a fairly large discrepancy. But if the discrepency is near the border of your criteria stay away from the trade if you don't have a pretty good idea why the market is causing this discrepancy.

2. MORE IMPORTANLY (I think) is to be willing to bet on discrepancies that do not quite meet your normal requirements to invest if you think you have a pretty good idea why the market is incorrectly causing this discrepancy. The fuddy duddy FAs on this forum are already using the first strategy but rarely the second one. But the second one HAS to work if they are even half as smart as they think they are.

3. Don't make the criteria for picking stocks to consider be the ones you are most adept at analyzing but rather let them come from a basket of stocks that for one reason or other the public is least adept at analyzing. Try to find stocks that have some aspect to them that will predictibly make them overvalued or undervalued. Like I did with Schwab and Taser. If you can get skilled at this enterprise, often as much art as science, you don't even need to have FA ability to have an edge in these bets. But having that ability will of course increase your edge. (As of now I have no idea how often a stock is mispriced due to reasons that an astute investor should be able to pick out. My personal economic situation had been such that I felt it wasn't worth looking into. That may have changed).

4. This fourth technique, unlike the first three is playing with fire. But I'm told it works. The jist of it was first brought to my attention by a weird book, written forty years ago called Horse Sense by someone named Fabricand. He was a mathmetican who later wrote a similar book about the stock market which I was also told works. But it is more illustrative to talk about the horse book.

After conducting research about thousands of horse races he came to the conclusion that a certain type of bet showed a long run profit. Although he gave a few variations and exceptions, the bet in a nutshell was a win bet on the favorite when at least one other horse was "similar" to it.

He then went on to give a whole slew of very precise, complex and convoluted rules (based on the information in the Daily Racing Form) to determine whether you could call two horses "similar". Some were really weird. For instance they became more similar if there odds were more dissimilar! In other words if the favorite was 6-5 and the 5-2 second choice did not quite meet the standards of similarity, it all of a sudden did if it moved up to 3-1?
What was going on here? He didn't explain why this method worked and he implied he didn't know himself. He just said that he had highly statistically significant results with the method.

He even admitted that he didn't really know how to handicap.
The only thing he explained at all was that he stuck to favorites because their inherent disadvantage, if bet randomly was much smaller than the other horses.

Meanwhile, again, multiple sources told me his method showed a nice profit and a giant improvement over random betting.

It took me a couple of readings to realize what was going on but then it hit me. Whether Fabricand himself realized it or not, his strange rules were designed, not to predict how likely a horse was to win but rather to predict the odds the public would make it! There is of course a high correlation but that was irrelevent to him.

In essence what he had discovered was the simple fact that horses, especially favorites, that were lower prices than WHAT ONE WOULD PREDICT based on the Daily Racing Form were MUCH more likely to win then the prerace prediction.

In other words if you are an expert at predicting the public odds on the toteboard and you predict they will be 5-2 (meaning the public thinks it will win about 25%, takeout adjusted) and the actual odds are 3-2 (meaning the public makes it about 35%) the actual winning chances are about 43%. This is an astounding increase in chances yet Fabricand supposedly found about one race out of nine where this occurred.

Now Fabricand's syndrome is well known in some cases. Namely when high price horses are significantly bet down. However those bets are often bad ones as the public often jumps on them and drives the price further down to minus EVland. But the situations Fabricand found were less obvious and thus less like to become self non fulfilling.

One interesting question regarding Horse Sense was the algorithmic nature of the rules he was using to predict (although he didn't realize himself he was doing this) what a horses odds normally would be (or to be more precise whether they normally would be about the same as another good horse in the race). Would an expert handicapper do even better at this task? Who knows? But we do know that that EXPERTISE WASN'T REQUIRED. And it still came up with insane edge swings. That would lead me to believe that in the short run, until lots of people learn it, there might be algorithmic rules for predicting what price the public will make a stock. Making it easier to follow the strategies in this thread.

So lets get to this fourth strategy. A dangerous one that I have yet to use. But expect to if I get deeper into this game. But before I mention it I want to remind you of what I just wrote. Fabricand found horses that he expected to go off at 5-2 that he would lose on if he took those odds but would win on if they were 3-2! (To make things clear this didn't include every time a horse was unexpectedly low. Most races the prediction of similarity was too fuzzy to jump on discrepancies.)

Anyway, method four does not involve betting on stocks where you can figure out why the marker doesn't agree with your evaluation. But rather betting on stocks where you have no idea why their price is different from what you PREDICTED it would be. Ironically you don't want to bet on stocks that are far away from that prediction because that has already attracted unwanted attention. Like the high priced bet down horse. If you are not a fundamental analyst and my theory is correct (which I admit I am uncertain of) you should still do well if your prediction talents are there. But it is better still if you are a FA.

Here is an example. You are a FA who can also predict what a stocks market price could be expected to be. You think this one will be 80. But it is 69. For no reason you can discern. Fabricand says this is enough to short it. You do your analysis and think it should be 59. Without Fabricand and me this is too close a call. But this short fits in with the second part of #1 above so you do it. Slam dunk. How can it not be? But notice that if you think the stock should be 59 and you predicted it would be 80, it means you can explain why the market is mispricing it (although not as much as you thought) in your eyes. If you couldn't you wouldn't have made your 80 prediction.

But what about if you yourself would (without firm conviction) estimate the stock as being worth about $80. The same price you thought the market would make it. Or what about if you feel you are unqualified to properly analyze the company (but qualified to predict what a stock like this would normally sell for). In those cases, (remember it can't be too obvious) Fabricand would say that you should STILL short it. I'm guessing he is right.

For those who don't want to wade through all this lets put it more simply. Get good at predicting what to expect the market will make a stock price. If you are right, and you disagree, and you know what you are doing, you have a certain edge. And don't be afraid to jump on moderate discrepancies. But if the price is unexpected be much more careful. Unless the surprising price is partially leaning toward you value.

If you want to play a little faster and looser you can try going further with things, as long as you can find surprising prices. Sort of like what some people call "trap lines" in football. If you find such a surprising price (but not TOO surprising, since everybody sees that) the idea would be to bet WITH the market. The opposite way as common sense and your inclination. Don't make this bet if you have strong feelings about the market's error. But if this was a stock that you had heretofore ignored because you rated it aboout the same way that you had predicted the market would, you should maybe IGNORE your cursory opinion and bet the other way. If you have a little inclination as to why the market may have this somewhat surprisng price, better yet.

This last technique is designed to squeeze out every bit of profit from your talent to judge what a stock price is expected to be. If you can do that and a stock is what you expected and it is because of flawed reasons you have a clear play. But in theory you ought to have good bets when the price is UN expected and you don't know the reason (or you have an inkling of the reason and it makes sense). This is a much more ticklish strategy though. So don't try it at home. Or blame me if it isn't working for you.