Belief:
Price is prime.
What this means to me:
The efficient market hypothesis is based upon the idea that all current relevant information is reflected in the price. Prices change for fundamental business reasons but also for the psychological reasons of investors. The only way to capture both the fundamental and psychological dynamics of the market is through the trade price.
What this belief gets me into:
This belief allows me to build trading systems based upon price action.
I can use indicators based on price to determine markets to trade.
I can use price indicators to determine when to enter a trade.
I can used price indicators to determine when to exit a trade.
I can use price action to determine my reward:risk ratio for a trade.
I can limit my losses according to price.
This will allow me to build mechanical systems that can be automated to execute trades for me.
I can trade many different markets.
What this belief gets me out of:
I am not required to analyze business balance sheets.
I do not need to pay as much attention to fundamental news.
I don’t need to spend hours on fundamental research to pick the right stock.
I may not need to know anything about the business itself at all.
I don’t need to find a reason why prices move.
Looking at the big picture.
Limitations of this belief:
Fundamental news can drastically alter the price of a stock (think pharmaceutical and bio-tech companies and drug approvals).
If I only look at price, I could miss important news announcements (earnings).
Bad price prints could force me out of (or into) a trade prematurely.
Relying only on price could lead to curve-fitting when backtesting.
I could miss out on stocks that represent extreme value (from a fundamental perspective).
Price relationships could be identified that do not make logical sense.
Utility of this belief:
By placing price first, it enables me to screen for markets meeting certain conditions, establish trade parameters for entry, exit and reward:risk, and simplifies (automates?) the decision making process. Combined with a healthy awareness of the big picture and fundamental news events, this is an extremely useful belief for me.
Conclusions:
Price reflects both fundamental and psychological opinion of the apparent value of an investment. Building a trading system around price movement allows for the creation of clear systematic rules to follow (or program). Profits and losses result from changes in the price after a position is entered. Trading is only a possible income source if prices change.