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.

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/p>

"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 get emotionally committed

to every one and might hesitate to do the needed arbitrages.

How to define those objectives?

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, brings an help for that.

 

Example of management of a "portfolio line" (= a given 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 to quit a 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

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.

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 its initial 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 1 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.

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 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 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, avoiding to taking 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 call 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 / values
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