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Chapter 15. Ten Lessons for Investors > Lesson 8: Respect the market

Lesson 8: Respect the market

Every investment strategy is a bet against the market. You are not only making a wager that you are right and the market is wrong but that the market will see the error of its ways and come around to your way of thinking. Consider, for instance, a strategy of buying stocks that trade at less than book value. You believe that these stocks are undervalued and that the market is making a mistake in pricing these stocks. To make money, not only do you have to be right about this underlying belief but markets have to see and correct their mistakes. In the process, the prices of these stocks will be pushed up and you as an investor will make money.

While you may be justified in your views about market mistakes, it is prudent to begin with a healthy respect for markets. While markets do make large mistakes in pricing stocks and these mistakes draw attention (usually after the fact), they do an extraordinary job for the most part in bringing together investors with diverse views and information about stocks and arriving at consensus prices. When you do uncover what looks like a market mispricing and an investment opportunity, you should begin with the presumption that the market price is right and that you have missed some critical component in your analysis. It is only after you have rejected all the possible alternative explanations for the mispricing that you should consider trying to take advantage of the mispricing.


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