Strategy

Rule # 1. Prices are always wrong.

That's where I start. The next step is to look for the greatest price dislocations. Where is the price most wrong? This begs another question, which is, What should the price be? Price is relative, so sometimes a simple, "price should be higher," or "price should be lower," will suffice.

There are many ways to look for this. Some kind of arbitrage can be a useful thing to look for, however, they never last forever. If there's an arbitrage built on a lasting trend, that's a good thing.

Another thing to look for is when there is a mistunderstood financial mechanism that affects the fundamentals themselves, such as the mechanism of the housing bubble where lending raised collateral values. Which brings me to rule #2.

Rule # 2. Understand what's happening right NOW.

You can make all the future predictions you want, and be right about them, but if you don't understand the undercurrents of the market right now, you won't make a dime. A lot of this is understanding who will have to hedge what, and how they will do that.

Rule # 3. What? When? and How?

Even after the first two rules, it gets harder, not easier. There are three components of every trade. You need to get all three right to make money. WHAT is the big picture macro story? For example, are we in a bull or bear market? Will the economy rebound in the next six months? etc. WHEN do I buy and WHEN do I sell? You can get the big picture right, but you still need timing. Finally, there's HOW do I monetize my idea? The right security is crucial. Pick the wrong one, and you go nowhere, inspite of accurate forecasts and perfect timing.