To Play the Market, You Must First Understand It

It's the ultimate nightmare. You're sitting down at a table in a game of strategy. You're betting your lifetime savings. And then you realize something that shakes you to your core. You realize that you don't understand the game.

Whether they recognize it or not, many investors are living the nightmare. They're risking their lifetime savings in a game of strategy called the stock market, and, unfortunately, they don't understand the game.

Over the next several columns, I'll highlight and explain 10 concepts and formulas you need to know in order to understand the stock market. If you grasp these 10 concepts and formulas, you will not suffer the nightmare scenario. You'll understand the market just as well as, if not better than, most of the players at the table.

Note also that I'll apply the 10 concepts and formulas, in this and upcoming columns, to current stocks, many of which are actionable buy ideas.

1: The purpose of the stock market is to facilitate liquidity.

Everybody knows that shares can be bought or sold in a matter of seconds in our all-cash, no-contingencies stock market. The market does an amazing job of providing liquidity. But that's all it does. The important takeaway here is not what the concept says, but what it doesn't say.

The stock market does not provide valuation appraisals. The purpose of the market is to tell you price. It does not tell you value. Also, the market doesn't exist to make you happy. It doesn't exist to make money for you. It doesn't exist to tell you how smart you are. It's not that the market is mean or evil. The market is indifferent. It doesn't care if you win or lose.

Last summer, I thought I was smart when I loaded up on Tecumseh Products (TECUA - commentary - Cramer's Take), paying $17 per share. With two of the company's three operating divisions sold, its financial statements required numerous adjustments prior to calculating value. Post-adjustments, the company was debt-free with excess net realizable cash (or soon-to-be realizable cash) of $400 million; it had a $1.1 billion (sales) compressor business worth more than $420 million.

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At time of publication, Alsin and/or ACM was long TECUA, ODP and MWA.B, although holdings can change at any time.

Arne Alsin is the founder and principal of Alsin Capital Management, an California-based investment advisor. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback; click here to send him an email.