Can you trade using IB Financial Models?
Tried trading before but couldn't really get into it with the way technical analysis skips the theory and you just end up drawing a bunch of lines on a stock chart.
What would happen if I were to say, take a company and build a typical banking model (DCF/Comps/Precedents ) and then use that Enterprise Value to trade over/under-valuations? I suppose this would more accurately be investing, not trading, but would it be possible to beat the market this way?
"The market can remain irrational longer than you can remain solvent"
What the quote means is that the underlying value (solvency) is always there but the market can take its time to realize this, as the price in the short term is guided more by trends and cycles (behavioral irrationality) and less by fundamentals.
Therefore - no, you don't trade with fundamental analysis. Though if your fundamental analysis is SOLID and the current market is under/overpricing your analysis, in the long term you can expect the market to adjust to your analysis.
What stock is everyone going with today
Sounds like a perfectly sensible idea...
here is the comment to look at on this noisy thread
This is investing. Buying below what you deem to be fair market value and selling when the market over values what you deem to be fair market value, and vice versa. Do this and you are more likely to be successful in the long run than by trading technicals. Just ask the Oracle of Omaha.
"This is investing. Buying below what you deem to be fair market value and selling when the market over values what you deem to be fair market value, and vice versa."
I would call this trading. Taking risk in the market based on a view. People say they're investing not trading because it sounds less risky. What many perceive to be trading instead of investing is actually guessing.
So to the OP, yes you could do that. The caver is you need to be right.
John Arnold, one of the best traders of all time said it well: "I try to buy things whenever they're trading below what [our] analysis shows to be fair value and sell things whenever our analysis shows that the forward curve is higher than our analysis of fair value".
http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/hearing0…
Be careful quoting John Arnold to support a securities investing philosophy- he traded natural gas. But the sentiment is the same. Supply and demand of a commodity (and the costs associated with production, transportation and other weather related issues) is a completely different beast than valuing a security.
What do you see as the difference? buying things that are cheap, selling things that are expensive is pretty transferrable in my mind.
Like I said, the sentiment is the same. But securities valuation relies on the present value of cash flow...the value of the enterprise. Commodities relies supply and demand - what makes something cheap or expensive in the future depends on the cash flow from buying or selling only, rather than what is produced by the actual commodity.
Answer this for me...what makes natural gas more or less expensive in the future? How can you determine whether or not its a good value today? What are you willing to pay for it now? You can only speculate - there is no model to predict the cash flow.
I missed where you said the sentiment is the same. In that case I agree with you. The mechanics are totally different but the sentiment is the same.
Would you agree the difference between trading and investing is that the investor accepts the beta and also tries for alpha, whereas the trader attempts to mitigate the beta and only generate alpha?
On your natural gas question,
"Answer this for me...what makes natural gas more or less expensive in the future?"
The shape of the curve in natural gas is determined by the calendar spreads which represent where the market has priced the value of storage. The value of storage is determined by the how much storage is physically required to balance the next day market relative to how much storage is physically available.
Natural gas in Jan 2020 isn't a made up number. It's the front contract fixed price plus a series of storage spreads. When people buy long term gas (or crude) they are actually buying the front contract plus a bunch of spreads.
You can absolutely model natural gas. In fact you can model it better than securities Natural gas is unique in that it is a closed system within North America. LNG does come/go but it's all from FERC regulated points and the exact flows are know. Additionally the physical market brings supply and demand to a balancing point each day, this matters because if you are a trader anticipating a catalyst to correct a mis priced instrument you get to see if you're right. A security has no terminal value and thus the idea that the market can remain irrational longer than you can remain solvent. Give me commodities over securities any day.
This is why also most good commodity traders tend to trade near the front if the curve. The gratification is fast. my favourite instrument to trade is the balance of month - no waiting to see who's right.
I am well aware of natural gas and how it is traded...that is what I do for a living. What you just described then, is that if it is storage spreads only, the price will never change. Storage spreads are not really daily balancing items, but seasonal...pricing the end of season storage for summer and winter (Nov1 and Apr1). The daily price movements are more about pricing in the coal to gas switching that you can pick up or drop off based on where you see the end of the season storage number coming out. BalMo swaps are more about watching the weather. LNG is a completely different beast...the amount of LNG export capacity coming online in the next four years is like adding a completely new region of the US, but obviously this is price dependent on global LNG prices in JKM or NBP markets, or South America (Cheniere's cargos have mostly gone south). This adds even more potential volatility depending on your view of utilization of these facilities. I agree its more complicated, but you are still speculating on what those supply and demand assumptions are and the trade is based on your view on their subsequent impact.
Lets not even get into cost of production and pipeline and infrastructure constraints for actually moving the gas to HH.
I agree you can model it, but you cannot model the value of the cash flows, which was the point of the OPs post.
Do you trade BalMo swaps or do you prefer swing swaps? Better to collect the daily cash difference if you're right, no?
This is why I am in opposition to your view. What is a stock? In its ultimate form it's partial ownership of a business. In the private world do you simply trade partial ownership? Absolutely not!
People forget this fact when they deem something trader. As an equity analyst it would be far too confusing to refer to it as trading because our trader (the dude who actually executes the trades we tell him to) would be highly confused.
Most everyone in our business considers a trade a short-term opportunity, or window, to make a decent quick return on a stock. Most everyone refers to identifying a long term catalyst and seeing either eventual earnings or multiple expansion as investing.
Hmm..so let's say I do something like this:
Would this make a reasonable investing strategy for a beginner?
DCF - unattainable growth and discount assumptions influence the price too heavily. Comps - looking past a few accounting ratios, usually they aren't that comparable. Precedents - The fair value of a security is not its value during a corporate finance transaction. Worst of the 3 methods you suggested.
As a very basic example, change your thinking to this, "company X trades at a steep discount to comparable company Y, however company Y has falling market share and is over-exposed to XYZ country/market. Whilst this implies a lower valuation, I believe that the market is overpricing this aspect given that .(insert reasoning based on extensive research and DATA), and I feel that once ( insert event/macro changes) happens the market will start to realise the true value."
...so basically you're saying the valuation metrics typically used in IB are trash. To be honest, I thought so too when reading up on the countless number of assumptions and ridiculousness when people assign a flat 5% growth rate because they couldn't find an equity research report to copy-paste from.
Off topic question, but why do clients pay so much to i-Banks for advisory then? The valuation techniques are clearly flawed, and I'm sure they could just tell someone in their own Finance department to do it.
I would personally love to do a more quantitative style of trading (not technical), as in looking for arbitrage or using probability theory to come up with strategies that actually are theoretically sound. However I'm thinking of starting my career in IB, which doesn't really give me much time or reason to learn this.
The reason there's a market is because people have different views of the future.
In order to trade, you must have an edge on the market. Otherwise you're leaving it all to chance.
Yes, investors have edges too. Private equity for example, usually has a Rolodex of management that can step in and improve companies. The reason HFs and PE has done so well over the last 15 years is because (for a variety of things) illiquidity was a profitable endeavor. You got paid more to hold things that couldn't be sold right away.
I suggest before you trade or invest , read as many books about investing as you can and see which style fits you.
That can be quantitative investing, stat arb, distressed, there's a ton of strategies to read up on.
Tldr; read more books before you invest.
Read Buffettology by Mary Buffett and you will be okay.
DCF inputs and multiples are often no less arbitrary than lines on charts
Truth.
A financial model is simply a tool to back up the qualitative assumptions of the investor. A FINANCIAL MODEL IS ONLY AS GOOD AS THE ASSUMPTIONS SOMEONE MAKES! In order to make assumptions you need to have a solid understanding of the fundamentals of the company and it's business drivers.
You cannot just build a model and expect it to spit out a target price saying whether you should buy or sell a security. I don't understand how people on this board can be so clueless to what drives a stock. Investing is an art and not a science.
I will redirect to this post which explains the matter further. http://www.wallstreetoasis.com/forums/to-all-freshman-and-sophomores
You need to read! Read about famous investors, their philosophy, and what they look for in a stock. Read about different styles and strategies. Try investing with simulator accounts. I realize most people don't have the passion for the markets that I do, but it's amazing what doing some research and having some common sense will do.
Rant over. Sorry kid.
Be first. Be smarter. Or cheat. ~Margin Call (film)
The only way to make money in the stock market is to cheat - front running. I can go on and on about global arbitrage investment, special situations investing, activist investing and on and on but - all of them make money on front running - gathering information from their contacts before the news hit the market.
looking for some easy and effective hacks models to look amazing throughout the entire week.
Assuming you're a college freshman or something who knows nothing about investing. Short answer: no, not even close. If you think you can make money on equities with cookie cutter IB models while equity hedge funds left and right are shutting down... you need to read up what second-level thinking means. If you're serious about investing, read Margin of Safety; great introductory book for anyone.
It is possible to beat the market this way. This is called "fundamentals" investing. There is a lot more to it than just filling in the cells properly in a spreadsheet, but you have the right idea.
You have to be extraordinarily good at it, however. Many thousands of very bright people try to do this everyday and most of them do not succeed. Still it would be good practice and if this interests you, go ahead and take some money you can afford to lose and try it out. There are also sites where you can build a fake portfolio with play money for practice. Don't do it expecting to make money, just treat it as a learning opportunity.
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