By definition anyone who invests in stocks has one common objective. He or she wants to buy low and sell high. Some investors want to sell first, and then buy back what they have sold at a cheaper price.  

Yet, more often than not, we end up buying high and we want to sell when the stock that we have bought climbs even higher. And when the market crashes, none of us want to buy anything at all. 

No one seems to define the terms low and high. So, what one investor regards as a low price, might be judged as a high price by another investor. The reason for this anomaly is that both of these terms, (low and high) are relative, and when one considers what is low and what is high, one has to consider other factors like the time horizon of the investor etc.

When we are buying or selling a stock we are indirectly making a forecast of what we expect the price will be in the future. The time horizon differs from one investor to another. Time Horizons can stretch from a couple of hours to a couple of years. Irrespective of the time horizon, there is an element of forecasting that is embedded in our decision-making. Our Expectations of what the price will be at the end of our defined time horizon, forms the basis of our forecast.

For the purposes of this post, I will stick to a time-horizon of 3 years. So, what we want to decide is whether the stock that we want to buy, has a good risk-reward at the Current Market Price, as compared with our Expectations of what the price will be after three years. 

In other words, we want to buy stocks where the expectations are low, and we want to stay away from stocks that are pregnant with expectations. The reason is that, low investor expectations translates to low stock prices and a better risk-reward. The inverse is equally true. 

How does one estimate the expectations that are embedded in the Current Market Price of a stock? The easiest way is to check the market capitalisation of the name that we want to buy or sell. The market capitalisation is the best indicator of the expectations of the market. In other words, the market capitalisation reflects the embedded expectations of the market participants. 

Once we arrive at a ballpark figure of the expectations that are embedded in the current market price of the stock, we can then compare that we our estimate of the stocks intrinsic value. If we find that the expectations embedded are low, and we have a sufficient margin of safety we should buy the stock. If, on the other hand, we find that the embedded expectations in the stock price are above our estimate of intrinsic value, we should sell the stock, or at least we shouldn’t buy it.

To conclude, we want to be buying stocks that have low expectations embedded in their Current Market Price - this will increase the probability that we end up playing a positive sum game.

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