aboutinvesting.org

Moral Hazard and Professional Asset Management

admin — Tue, 22 Nov 2011 13:15:30 +0000

Moral hazard is a very important concept in information economics and game theory. It refers to a situation in which the agent makes decisions about a project involving risk on behalf of the principal. Generally, the principal bears the costs while the agent does not. Agents act differently from how they would if they were fully responsible and exposed to the project’s risk. Agents may choose risky projects because this way they maximize their expected payoffs.

Moral hazard can be present in professional asset management for various reasons. The truth is that investment decisions are very complex and there are lot of information asymmetries as well. Investment managers (agents) use methods, models and data to make investment decisions that individual investors (principals) are not aware of. Very often, investment managers focus on short term results taking extreme risks, a situation that individual investors cannot identify. Investment managers focus on short term performance to maximize their bonuses and attract new clients.

Extreme risk taking can take the form of insufficient portfolio diversification, concentration to a limited number of asset classes or securities and extreme leverage. Investment managers form portfolios concentrated to those asset classes or securities that are likely to outperform the benchmark during a specified time period. In this case, investment managers expose client’s money to specific, idiosyncratic risks that otherwise could be diversified away easily. For example an asset manager may overweight high yield (junk) bonds or invest in companies with high bankruptcy risks. Moreover the asset manager could use margin or leveraged structured products. These strategies have high expected returns if the good scenario is realized but catastrophic consequences if the bad scenario is realized.

Extreme risk taking comes from the fact that bonuses and management fees depend on whether performance is better than a specified benchmark. Moreover, typical contracts do not assume any responsibilities for asset managers if anything goes bad. Thus, investment managers who manage billions of dollars have the incentive to outperform the benchmark as soon as possible to maximize their payoffs. A margin of 5% percent over the benchmark in a given year, is sufficient to secure investment managers’ financial independence for the rest of their lives.

Moral hazard risks are evident in the asset management industry. However do not think that the asset management industry is a scam or that moral hazard risk is everywhere. Most asset management firms have a long history in the business and employ mechanisms to limit risk taking. Risk management departments and individual whose bonuses do not depend on performance monitor portfolio management in a daily basis.

Professional Investment Management

admin — Mon, 21 Nov 2011 13:15:09 +0000

It is true that, on average, professional investment managers have the proper education and experience to manage one’s money more efficiently than an individual investor would do on his own. In most cases, mutual fund managers and investment managers in general, have graduated from the best business schools globally, and very often, they hold a Ph.D. in areas related to the investment management industry such as financial economics, financial mathematics, econometrics, risk management etc. Thus, they posses priceless knowledge in making investment decisions compared to an average individual.

Institutional investors employ several professionals from different areas related to investment management. Economists and macro analysts can discover investment opportunities worldwide while a retail investor has neither the knowledge nor the data or resources to do so. Equity analysts can find sectors, industries and individual stocks that are very likely to outperform. Portfolio strategists and portfolio managers can form optimal portfolios with very efficient risk return profiles. The average retail investor does not diversify her portfolio at all! Risk managers and financial engineers can mitigate risk and design exotic products to hedge specific kinds of risks.

It is true that institutional investor have the resources to gather and analyze proprietary data that costs several thousand dollars. Thus, investment managers have superior information and most of the times are several steps ahead. They also deal with lower transaction costs compared to retail investors. Their trading volume worth billions of dollars and thus they have privileges when dealing with stock brokerage firms. Furthermore, assets under management suffice to achieve diversified portfolios. On the contrary retail investors have limited capital and cannot diversify beyond a handful of stocks.

The decision of whether to manage your money on your own or trust a professional wealth manager is not trivial. The investment management industry has its own disadvantages as well. There is a lot of research to be done before making such a decision. You have to think about the challenges of managing your money on your own as well as whether you have the resources and knowledge to do so.

Basic Rules in Trading and Investing

admin — Fri, 18 Nov 2011 13:35:29 +0000

While there are neither “official guides” nor “universal rules” for becoming successful in stock investing and forex trading, there are some general rules that could probably help you to form a framework or a starting point in making your very personal rules. The rules that follow are somehow universally accepted and proposed by the most profitable traders and investors globally.

Probably the most important rule is that you must follow your rules! This may sound strange but is crucial. The majority of traders and investors fail and lose money simply because the fail to follow their own rules! Just make a search in any investing related book, blog, or website… You will find countless cases where a profitable trader experienced a significant loss simply because he made things in a different way just for one time because he thought that this deviation from the rules was the right thing to do.

A second general rule has to do with how to deal with losses. You should not risk more than a specific percentage of your total wealth, portfolio in a single trade. You may (think you) have the best entry and exit rules… But things change, people change, markets change! Stock prices and currencies may enter a new regime at any given time. Accept this fact and do not take extreme risks, do not risk a great portion of your capital in a single trade!

An old saying in financial markets that you have probably heard goes “Let your profits run and cut your losses quickly”. If a trade turns out to be wrong do not hesitate to exit. On the contrary, if a trade confirms the hypothesis behind it do not hurry to claim the profit. Prefer to exit a profitable trade based on a rational rule rather than a percentage profit rule. Do not set price targets as well.

aboutinvesting.org

The Importance of Rules in Trading and Investing

admin — Fri, 18 Nov 2011 13:03:56 +0000

Almost any profession has its own rules and guidelines. The existence of rules and guidelines help people to make better decisions in complex and dynamic environments. Currency trading and stock Investing are not exceptions. Forex traders and stock investors realize very soon that turbulent markets are their own worst enemy! Market participants that do not follow any specific portfolio management rules experience significant losses during volatile periods in financial markets.

Successful traders have a list of specific rules that follow during each step of the investment process. They have rules about what stocks to buy and when, what stocks to sell and when and about what to do when stock market volatility increases suddenly. Because of this, the existence of a specific plan, they feel more safe and comfortable. Uncertainty makes people feel uncomfortable, and people that feel nervous and anxious make wrong decisions!

Thus, the existence of a set of rules can help you during the investing marathon twofold: firstly, well researched rules can improve your trading record instantly and secondly, the existence of rules, a plan, will make you feel more comfortable and secure a fact that will help you avoid behavioral mistakes.

But, beware! In currency trading and stock investing there are neither “official guides” nor “universal rules” of doing things the right way! You should make your own research and find rules that seem intuitive and make sense.

aboutinvesting.org

Diversify your Investment Portfolio!

admin — Thu, 17 Nov 2011 12:51:58 +0000

Many financial economists say that “diversification is the only free lunch one can have in financial markets”. We totally agree! Whether you are a long-term investor or a high frequency trader, you must understand that diversification is very important. Investors who understand and utilize the principles of diversification soon realize its significant benefits. Diversified portfolios have lower volatility and can reduce the adverse consequences of an unexpected bankruptcy. It is much to realize a bankruptcy in a 10-stock portfolio than a bankruptcy in a single-stock portfolio!

Moreover, investors who form diversified portfolios increase the odds of being profitable. More specifically, a portfolio with 10 stocks that are likely to outperform has, on average, a higher probability to outperform that a single-stock portfolio. If you consider yourself as an above average stock picker then you should form portfolios of stocks and not concentrate tour exposure to one or two stocks. The same holds for currency bets or business ventures!

StockTradingCollege.com‘s Asset Allocation and Portfolio Management articles are two topics that you should be aware of if you want to be profitable. Invest a couple of minutes and take a look at investopedia’s Introduction to Diversification. If you are a more technical-oriented reader you will appreciate wikipedia’s entry for Diversification.

aboutinvesting.org

Successful Traders are Intelligent!

admin — Thu, 17 Nov 2011 12:24:15 +0000

Well, yes that’s the truth! If you want to be a successful trader you need to be intelligent! We do not mean that you have to hold a Ph.D. in nuclear physics though! Even a 180-iq-guy will fail if he is not well prepared! Successful trading requires knowledge, the proper mindset, money that you will not need the day after, and a plan. Intelligent investors understand how stock markets work and have a clear picture about what they want from the stock markets. They have clear goals.

Goal setting is a key step in a Personal Finance plan. Traders and investors with clear goals know when to increase or decrease their exposure to risky investments. Furthermore they can define in a better way what types of investments are more appropriate for their investment portfolios.

Knowledge is probably the most important determinant of trading success. If you know how things work then you can avoid critical mistakes. Often, beginners in stock and forex trading trade to much and end up paying a fortune in brokers. Intelligent investors, calculate the expected return of each position and enter a trade only when the profit margin is sufficient to cover trading costs and is fair for the risk undertaken.

aboutinvesting.org

I am looking for the Best Investment Strategy!

admin — Wed, 16 Nov 2011 12:44:47 +0000

Every trader is looking for the best investment strategy. The best investment strategy is, at the same time, abstract and with well defined characteristics. It is a strategy that generates profits without significant losses, though many traders are looking for an investment strategy that never picks losing trades! How feasible is this? A flawless investment strategy is equivalent to a money-making machine! Can you imagine such a machine? We can’t! Stock prices are in some extent random, and the determinants of stock and currencies prices are not so trivial to analyze. The best investment strategy turns out to be a more complicated thing and without doubt, not without flaws.

Whether you are interested in stock trading or currency trading you will probably find interesting a view on what the the best investment strategy really is from StockTradingCollege.com

aboutinvesting.org

Stock market trading is not kids’ stuff!

admin — Wed, 16 Nov 2011 12:02:07 +0000

Every beginner in stock market trading should know that buying and selling stocks is not an easy business. There are no free lunches and there are considerable risks that you should take account of. At the end of the day it is your money that is at stake. Profitable stock trading requires certain skills such as critical reasoning, the ability to understand complex matters and a behavioral setup that will guarantee you stick to the plan during volatile markets. On the other hand we do not believe that you have to score over 150 in IQ tests. Moreover, trading is more an art than science. It is all about educating yourself.

Before risking your own money do some paper trading. There are many sites that provide the option to trade using virtual money. However keep in mind that is very different when you trade using real money.

aboutinvesting.org

Investopedia

admin — Tue, 15 Nov 2011 14:11:45 +0000

Investopedia is one of the largest sites (if not the largest) devoted to educating people about investing. Investopedia was founded by Cory Janssen and Cory Wagner in 1999 and started as a financial dictionary. In 2007, Investopedia was purchased by Forbes. In 2010, Forbes sold Investopedia to ValueClick. Investopedia averages over 2 million page views per month andhas over 2,000 articles 5,000 dictionary entries and a large number of tutorials on investing and other financial topics.

You can find articles about stocks, bonds, mutual funds, ETFs, options, futures, and real estate. There are also tutorials for beginners in investments, experienced and active traders.

aboutinvesting.org

Welcome!

admin — Tue, 15 Nov 2011 13:13:45 +0000

Welcome to aboutinvesting.org!

aboutinvesting.org delivers the best content about stock trading and investing, intraday trading, currency trading (forex), real estate investments, derivatives, commodities, mutual funds, and exchange traded funds (ETFs) from various web sources.

aboutinvesting.org is a non-for-profit website. Our mission is to share with fellow traders and investors high quality and unbiased information about trading and investing. In aboutinvesting.org you can find articles written from aboutinvesting.org contributors as well as articles from others sources.

Feel free to contribute to aboutinvesting.org. You can send comments, articles and resources at info{at}aboutinvesting.org (replace {at} with @).

aboutinvesting.org