Using stock images
for portfolio management

 
(Leif Ericsson on his way to discover America, 10 centuries ago)

Stock management is like ocean-going navigation.

It starts with a portfolio strategy.

However flexible and opportunist it should be, that strategy needs also, in the long
run,we could even say for survival, some discipline, rules and objectives.

Without rules and objectives, a financial assets portfolio would be a ship without a
skipper.

  1) Define precise objectives

(based on - among others - stock images)

A full set of investment management objectives, for each portfolio
line,
includes normally:

  An acceptable buying price,

  A projected share of the portfolio
     (for diversification) (*)

  Deadlines for buying
     (or forgoing) and selling,

  A number of buying / selling fractions,

  Target prices (interim + final),

  A stop-loss price.

(*) Some details on portfolio diversification

Diversification by asset, industry, country, stock and also style (image type) is a
personal balance between selectivity and safety.

We will not elaborate on this point, but obviously an investor should devote a full
attention to how to arrange his/her "stock basket".

The first criterion, like for any basket, being ...its size.

A behavioral point not to forget is that

* The more varied and dispersed are the assets, the less easily they can
    be given individual attention,

* Conversely, the more concentrated they are, the more an investor gets
    emotionally committed to every one and might hesitate to do the needed
    arbitrages.

How to define those objectives?

What can help are the PMV / Potential Market Values (they take into account the
extreme potential images), spiced with some additional reasoning and prudence rules
summed up in the graph below,


Example of management of a "portfolio line"
   (= a specific stock or asset)

Price

 

 

Sell half of the line

above 52 (3)

Sell all
after 18
months
(3)

52


Buy a
fraction (1)

Buy more (2)

Keep (2)

35

 

Sell all under 35

0

1 m

9 m

18 m

Time

(1) possibly wait 1 or 2 months before deciding the final objectives.

This is the idea of a "real option": invest a small amount as a test, with the clear
objective
to go further or quit after getting some more knowledge on the asset
in sight.

(2) except new event reducing the stock prospects (avoid to be "anchored"

on an overoptimistic prior valuation)

(3) except new event that change in a fundamental and very positive way the
      nature of the stock

  2) Apply discipline

To respect those navigation rules is a matter of discipline.

Nothing is more dangerous than to feel committed (commitment bias)
to maintain or increase an investment after putting "the foot in the door" if this
investment does not reach our objective.

Thus, better consider the above limits as imperative, particularly the downside
selling limit
.

As the saying goes : "In markets, discipline comes over conviction".

That can lead to some existential introspection:

  Yes, "Know thyself" applies also to stock management.

  Here, I can mention a little goody for investors: the 
     Psychonomics profiler quiz.

With all that, you are on the way to the "behavioral portfolio management",
the active complement of the behavioral stock analysis.

  3) But what about adjustment?

Discipline is OK, but it doesn't mean stubbornness.

We see that the above illustration includes "signals" and "valves" that incite to react.

But also, if the state of affairs changes fundamentally, one has to avoid
"anchoring" in it sinitial estimate.

Objectives might have to be altered if there is some deep change.

While acting in the market accordingly to the signal as anticipated, one has to adjust
the stock valuation, to take into account the change of prospect.

"Deep change" is the key.
What discipline avoids is to change opinion just because:

* Things evolve just a bit differently. Crucial information has to be separated
    from "noise".

* Or the investor feels some emotional fit of mood that distort is perception
    of reality.

All in all, real reasons to change one's strategy are not so frequent, at least after the
initial one month waiting period.

On condition to use that period to make serious "homework", by gathering the most
information and refining the analysis that determine the objectives.

  4) By the way, what is decision making?
         And the related traps?

Everybody has its own "decision-making style", whatever the decision is about
(thus not only in the field of finance)
.

Usually three very personal elements play a part, a kind of decision-making triangle

The role of Reason.
   
Reason is dominant in decision-making when a decider:

- Clearly identify ones own goals and make decisions that are consistent
  with them.

- Carefully collect and analyze information, and make a synthesis in a logical
   way.

- Imagine the various possible solutions (scenarios) and their probabilities.

- Devise way out solutions and whenever possible make decisions that are
   reversible in case things turn bad, even if the cost is to "cut one's loss"...

Sentiment, emotions that intervene in decision making

They are quite varied, but the main ones are::

- Fears, hopes, greed, attractions, wishes, repulsions.

- Also the ever present mimicry that tends to make us follow the herd, which
   by the way
is sometimes necessary, but on condition not to abandon our
   lucidity....

Of course, we have to be wary of emotions, so as not being their puppet, to
avoidi to take our whishes or dreads for realities.
On the other hand to decide has no effect if it is not followed by actions.
And here we must admit that if we feel no emotions, of the kind called guts
(see below), we are not really stimulated to act.

Instinct (guts) and automaticity trigger many decisions.

This activator / motivator / accelerator is useful.

But it might also trap us into habits, routines, simplified heuristics, anchoring
in the past, or even magic thinking, all things that can be disguised as instinct.

Also there are some traps:

* Laziness and impatience, which incite not to take the trouble to collect

information,and to rush blindly against windmills.

* Or conversely, excessive meticulousness and wavering that delay the
   decision- making process and in some cases miss the market bus.

Just a tip. Altogether, one has to keep cool when having to decide.

For this purpose here is a little trick but with big effects: antistress

Here also a reminder of some investment precautions
resulting from Behavioral finance research

1 - Activity

Avoiding inertia and indecision as well as

hyperactivity

2 - Reaction

Being sure to adjust to new situations and

information

3 - Anchoring / focusing

Trying not to be anchored on past
references / value
s

4 - Framing, heuristic

Avoiding narrow interpretations and over-
simplifications

5 -Fallacy, attention

Revising erroneous knowledge and beliefs

6 - Attitude - Aversion

Avoiding biased expectations of pleasure /
pain that would follow decisions

7 - Emotion

Avoiding the primacy of emotions over
reason

8 - Mimicry,
     manipulation

Being wary of biased social influences on
decisions

9 - Magic

Being wary of illusive expectations and
beliefs in pseudo-certainties

10 - Pride

Trying not to be blinded by one's ego

11 - Preferences

Trying to have clear and consistent
priorities

12 - Tilting

Trying to use - or to protect from -
market mispricing

separ

This page last update 09/11/14
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