For an investor with a long-term view, the value is best measured in terms of growth, earnings, market strength, and so on.
However, a trader can benefit by following the technical price signals that were discussed earlier.
The striking difference between the two approaches is that long-term investors look at the future earnings growth, while traders look at past price levels.
Who is right? Our gut feeling is that future earnings growth expresses real value.
However, past price levels express the market's interpretation at that time of what the future earnings growth will be.
Past price levels only represent a speculation of future earnings growth.
Therefore, for traders to look at past prices levels in order to predict future prices is highly speculative.
What a trader is saying is that "the stock was more expensive yesterday. Therefore, it is now comparatively cheap".
This measure, however, does not give him a clue whether tomorrow's price will still be cheaper.
However, what most people tend to forget is that buying and selling a stock mainly means dealing with other people.
When you buy a stock, it means that you find it "cheap".
It also means that someone else finds it "expensive".
This means that the concepts of "cheap" and "expensive" had better be measured against the group of traders who are active in the stock instead of against some other measure.
Why is this? The simple answer is that on the stock market, we are not trading "reality", but rather the perception of that reality.
Therefore, instead of talking about "cheap" or "expensive", we'd better talk about "expectation".
Indeed, nobody really buys a stock because it is cheap, or because it is a good stock.
These reasons (and others) are rationalizations of the buying act.
If it is not to cover an existing position, the only reason for a trader to buy a stock is because he expects the share price to increase.
This trader expects to sell his position later at a profit.
In the stock market, you buy a stock because you want to resell it at a higher price.
Your feeling about the expensiveness (the value) of the stock is intimately linked to your expectation to sell the stock higher or not.
That expectation itself certainly depends on the stock price, but it also depends on other traders' expectations (you'll need to find a buyer).
We could say that a trader's expectation at time t of a further price increase is inversely proportional to the Return on InvesTM
ent (ROI) this trader is running at time t.
This means that if you already have a 50% profit, for example, your expectation for a further profit increase is lower now than at the time you bought the stock when you had 0% profit.
I found out that the average ROI of the pool of active traders gives a good representation of the value of a stock as perceived by said traders.
The upper panel of figure 4 represents the minute-by-minute stock price of the company OpenWave, while the lower panel represents the average ROI for a volume of 30 million shares.
The upper boundary
(Dotted Red Line) says that "At this high level of collective ROI, the average expectation for a further price increase is very low, and we may expect more profit taking to occur"
The lower boundary
(Dotted Green Line) says that "At this low level of collective ROI, the average expectation for a further price decrease is very low, and we may expect more bargain seekers"