Portfolio Management

Portfolio

                  Portfolio is a combination of securities such as stocks, bonds and money market instruments.

                    Diversification of investments helps to spread risk over many assets. A diversification of securities gives the assurance of obtaining the anticipated return on the portfolio.

             In a diversified portfolio, some securities may not perform as expected, but others may exceed    the expectation and making the actual return of the portfolio reasonably close to the anticipated one.

Portfolio Management

                      The art and science of making decisions about investment mix and policy, matching investments to objectives, asset allocation for individuals and institutions, and balancing risk against.performance.

Portfolio management is all about strengths, weaknesses, opportunities and threats in the choice of

 debt vs. equity, domestic vs. international, growth vs. safety, and many other tradeoffs encountered

in the attempt to maximize return at a given appetite for risk.

Modern Portfolio Theory - MPT

A theory on how risk-averse investors can construct portfolios to optimize or maximize expected return based on a given level of market risk, emphasizing that risk is an inherent part of higher reward.

Also called "portfolio theory" or "portfolio management theory."

There are four basic steps involved in portfolio construction:
-Security valuation
-Asset allocation
-Portfolio optimization
-Performance measurement

Granular Portfolio

                      A type of portfolio that is well diversified across a wide variety of areas, typically with

a significant number of holdings. Because these portfolios contain a large number of positions over many areas, they are considered to have a lower overall risk profile. Conversely, portfolios that have "low granularity" have fewer positions or contain highly correlated assets, are less diversified and have a higher overall risk profile.

Zero-Investment Portfolio

                                        A group of investments which, when combined, create a zero net value. Zero-investment portfolios can be achieved by simultaneously  purchasing securities and selling equivalent securities. This will achieve lower risk/gains compared to only purchasing or selling the same securities.

Diversification

               A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio.

Diversification strives to smooth out unsystematic risk events in a portfolio so that the positive performance of some investments will neutralize the negative performance of others. Therefore, the benefits of diversification will hold only if the securities in the portfolio are not perfectly correlated.

Tactical Asset Allocation

                      An active management portfolio strategy that rebalances the percentage of assets held in various categories in order to take advantage of market pricing anomalies or strong market sectors.

Portfolio Insurance

                A method of hedging a portfolio of stocks against the market risk by short selling stock index futures.

Rebalancing

             The process of realigning the weightings of one's portfolio of assets.

  

INVESTMENT ALTERNATIVES

                             Today's investor is faced with an overwhelming number of choices when it comes to implementing an investment strategy. Since the right combination of investments in the right types of accounts can mean reaching your goals sooner rather than later, it is important to know your alternatives. Below is a list of investments alternatives.

Stocks   

                     A share of stock represents partial ownership in a company. Initially sold by the company itself to raise money, the shares are then bought and sold by investors in the secondary market. Shareholders can vote on the company's major decisions, and receive dividends as their share of profits. As a company's stock price rises or falls, so does the shareholders' investment.

Bonds
                          Like stocks, bonds are issued by companies and governments to raise money to fund a variety of projects and operations. Unlike stocks, a bond is a loan that the issuer promises to pay back, usually at a set interest rate. Bonds are then bought and sold by investors in the secondary market.

Mutual Funds
                         One of the most convenient investment options available, mutual funds offer investors the benefits of professional management and diversification. By pooling the assets of many investors, and pursuing a set investment objective, mutual fund managers are able to provide investors with buying power unavailable to individual investors.

Insurance and Annuities
                         Insurance and annuities can help you work towards life's goals and plan for the unexpected. Offering tax-deferred growth, the option of income for life and a guaranteed death benefit, annuities can be a way to supplement your 401(k) or IRA retirement savings plan. An annuity requires you to make one or a series of payments and, if you choose, the insurance company will pay you a regular stream of income in the future in return. With life insurance, you pay premiums to the insurance company which entitle your beneficiaries to a specified benefit payment should something happen to you unexpectedly. This is all subject to the paying ability of the issuing insurance company.

Cash and Cash Equivalents
                      Treasury bills, money market mutual funds, certificates of deposit, even passbook savings accounts are all considered cash.* Returns on these types of savings and investments are usually low because they often involve little or no loss of principal.But as a relatively safe place to keep funds that you may need to access readily, they play an important role in any investment plan.

Tax Sheltered Investments
              Benefit from tax deferred investments such as retirement plans and municipal bonds. Take advantage of income opportunities that are free of federal, state, or local taxes.

Real estate

                          For most of the investors the most important asset in their portfolio is a residential house. In addition to residential house, the more affluent investors are likely to be interested in the following type of real estate:

v  Auricular land

v  Semi-urban land

v  Time share in a holiday resort

 Normal Diversification- This occurs when the investor combines more than one asset in the portfolio.

 

                                                                                                          75% 0f total risk

                                                             Unsystematic Risk

 

             Risk

 

                                                            Systematic Risk                      25% of total risk

                                     

                                                3                      5                     10                 15

                                 Number of Assets

Unsystematic Risk:

                 It is that part of an assets total risk which can be eliminated through diversification.

Systematic risk:

                    It is that risk which cannot be eliminated. It is inherent in the market place. It arises on account of the economy-wide uncertainties and the tendency of individual securities to move together with the change in market. For example changes in the interest rates by the Government, Inflation rate and etc.

An overview of the Investments Alternatives

	Return		Risk	Marketability/ Liquidity	Tax Shelter (in India)
	Current Yield	Capital Appreciation
Equity Shares	Low	High	High	Fairly High	Section 80L benefit
Non-convertible Debentures	High	Negligible	Low	Average	Nil
Equity Schemes	Low	High	High	High	Section 80L benefit
Debt scheme	High	Low	Low	High	No tax on dividends
Bank Deposits	Moderate	Nil	Negligible	High	Section 80L benefit
Public Provident Fund	Nil	High	Nil	Average	Section 88 benefit
Life Insurance Policies	Nil	Moderate	Nil	Average	Section 88 benefit
Residential House	Moderate	Moderate	Negligible	Low	High
Gold ,Silver	Nil	Moderate	Average	Average	Nil

Technical Analysis of Stocks

Technical Analysis

    Technical Analysis guides to pick a stock at right price and at right time.

Tecnical Analysis

                         People advocating technical analysis hold that all factors influencing price that fundamental traders are using already is reflected in stock prices and that fundamental analysis therefore is not effective. Fundamental economic estimations of growth and profit margin are moreover far to uncertain. It is people that are buying and selling, and that is why the price will reflect human psyche, at least in the short run.

Technical Analysis

                             Technical Analysis is an approach that uses information of past stock behavior in order to forecast future price movements. Within the technical analysis community there exists several schools with different techniques, but they all have in common that they use price and volume history. A basic thought is that it takes time before the market reacts upon new information and that pattern often occur in price behavior which makes forecasting possible.

Technical Analysis

Rationale of technical analysis

1.    The market price of security is determined solely by supply and demand. Any shift in the supply and demand relationship can be detected sooner or later in the action of the market.

2.    The study of prices gives one a feel of direction of price movement.

3.    Technical analysis helps traders and investors alike to review their investment decisions faster.

4.    Technical analysis brings to bear systematic and often disciplined approach to the investment process.

5.    Technical analysis often gives an advance signal of an impending reversal in the markets.

Pitfalls of Technical Analysis

1.                  Technical analysis is not an exact science. It is the study of a dynamic situation and we must therefore continuously review your decision in the light of Fresh price action.

2.                  The Basis of technical analysis may be easy to learn but the nuances are difficult to implement and master.

Charts:

1.      On the basis of time frame------

·         Daily charts: Shows day’s open, high, low and closing prices.

·         Weekly charts: Shows week’s open, high, low and closing prices.

·         Monthly charts: Shows month’s open, high, low and closing prices.

2.      On the basis price depiction------

·         Line chart: Only the closing price of each day is plotted.

·         Bar chart: Only the open, high, low and closing prices are plotted.

·         Candle stick: Only the open, high, low and closing prices are plotted in the form of Japanese candle stick. 

Trend:

           A trend indicates that there exists an inequality between the forces of supply and demand.

·         If supply is more than demand, the trend will be down..

·         If demand exceeds supply, the trend will be up.

·         If demand and supply are nearly equal , the market will move side ways – what we call it as range.

            A trend may thus be considered as a phase in a markets movement when prices are going in a particular direction.

Types of trends:

§  Rising trend: Prices make higher highs and higher lows.

§  Falling trend: Prices make lower highs and lower lows.

Correction:

               The term correction doesn’t necessarily mean falling prices. It simply means a smaller price move which is counter, i.e. opposite to the prevailing trend.

Trend reversal:

            When the basic and necessary condition defining a trend is invalidated, it is a signal of trend reversal.

·         When, after consistently making higher highs and higher lows in an ongoing rising trend, the market index or a stock as the case may be, makes a lower high and lower low formation, the uptrend is said to have reversed direction into a down trend.

·         In rising trend, a traders strategy would be to buy stocks on any price falls (corrections), and then wait for price to resume its up trend.

·         Conversely, when the main trend is down, a traders strategy would be to exit stocks on price rises (correction) and wait for lower prices to re-enter ino the market.

Trend Lines:

·         To depict an uptrend, a trend line has to be drawn on a price chart by joining the successive higher lows being formed., because higher lows being a condition of uptrend.

·         To depict a down trend, a trend line has to be drawn by joining the successive a lower highs being formed, because lower highs being a condition of a down trend.

ü  Support line:

                 A trend line formed by joining the higher lows of an uptrend is a supporting line.

                  Prices are likely to find buying support in the vicinity or around, a support trend line.

ü  Resistance line:

                   A trend line formed by joining the lower highs of a down trend is a resistance line.

                    Prices are likely to find selling pressure in the vicinity or around, a resistance line.

§  Price – Volume relationship:

                    Any price move supported with higher or increasing volumes is a suggestive of a strong trend.

§  Rising prices along with rising volumes is a bullish.

§  Rising prices along with falling volumes is a bearish.

                            Any price move which is not supported by a volume expansion is suggestive of a weak trend.

                        Rising

§  Rising prices accompanied by falling volumes is a potentially bearish sign.

§  Falling prices accompanied by falling volumes is a potentially bullish sign.

Line Chart of Closing prices

ü  Bar chart is the most popular chart used where in the highest price, the lowest price and the closing price of each day are plotted on a day to day basis. A bar is formed by joining the highest price and lowest price of a particular day by a vertical line. The top of the bar represents the highest price of the day, the bottom of the bar represents the lowest price of the day and a small horizontal hash on the right of the bar represents the closing price of the day. Some times opening price of the day is marked as hash on the left side of the bar. A price bar char is illustrated below:

Price bar chart

ü  Japanese candlestick charts shows the highest price, the lowest price, the opening price and the closing price of the shares on a day to day basis.

§  The highest price and the lowest price of a day are joined by a vertical bar.

§  The opening price and closing price of the day which would fall between the highest and the lowest prices would be represented by a rectangle so that the price bar char looks like a candlestick.

                   There are mainly three types of candlesticks:

-          The white candlestick used to represent the situation where the closing    price of the day is higher than the opening price. It indicates a bullish trend.

-          The black candlestick is used when the closing price of the day is lower than the opening price. It indicates the bearish trend.

-          The doji or neutral candlestick is one where the opening price and the closing price of the day are same.

                   Japanese candle stick chart is illustrated below:

Japanese Candlesticks

Chart Patterns:

             When the price bar charts of several days are drawn close together certain patterns emerge. These patterns are used by the technical analysts to identify trend reversal and predict the future movement of prices. The chart patterns may be classified as

ü  Support and resistance patterns are price levels at which the downtrend or uptrend in price movements is reversed.

ü  Support occurs when price is falling but bounces back or reverses

direction every time it reaches a particular level. When all these low points are connected by a horizontal line, it forms the support line. In other words, support level is the price level at which sufficient buying pressure is exerted to halt the fall in prices.

ü  Resistance occurs when the share price moves upwards and the price

may fall back every time it reaches a particular level. A horizontal line joining these tops forms the resistance level. Thus, resistance level is the price level where sufficient selling pressure is exerted to halt the ongoing rise in the price of a share.

               The following figure illustrates support and resistance level:

Support and Resistance levels

              If the scrip were to break the support level and move downwards, it has bearish implications signaling the possibility of a further fall in prices. Similarly, if the scrip were to penetrate the resistance level it would be indicative of a bullish trend or further rise in prices.

ü   Reversal patterns are chart formations that tend to signal a change in direction of the earlier trend. Price movements exhibit uptrends and   down trends. The trends reverse direction after a period of time. These reversals can be identified with the help of certain chart formations that typically occur during these trend reversals.

§  Head and shoulder formation is the most popular reversal pattern

     which usually occurs at the end of long uptrend. This formation

     exhibits a hump or top followed by a still higher top or peak and then

     another hump or lower top. This formation resembles the head and

     the two shoulders of a man and hence the name head and shoulder

     formation.

ü  The first hump, known as left shoulder- when the prices reach the top

     under a strong buying impulse. Then trading volume becomes less and

     there is a short downward swing.

ü  This is followed be another high volume advance, which takes the

     price to a higher top known as head. This is followed by another

     reaction on less volume which takes the price down to a bottom near

     to the earlier downswing.

ü  A third rally now occurs taking the price to a height less than the

     head but comparable to the left shoulder resulting in the formation

     of right shoulder.

ü   A horizontal line joining the bottoms of this formation known a the

      neckline.

         The head and shoulder formation usually occurs at the end of a

     bull phase and is indicative of reversal trend. After breaking the

     neckline, the price is expected to decline sharply. Following figure

     illustrates the head and shoulder formation:

Head and shoulder Formation

§     Inverse head and shoulder formation is the reverse of head and shoulder formation and is really an inverted head and shoulder pattern.

ü  The first bottom is the left shoulder

ü  Then comes a lower head

ü  Followed by a third bottom which is termed the right shoulder?

ü  The neckline is drawn by joining the tops from which the head and the right shoulder originate. When the price raises above the neckline the formation of the pattern is completed.

                     This pattern occurs at the end of a bear phase and indicative of   an  oncoming bullish phase.   

Inverse head and shoulder pattern

§  Other reversal patterns are double top formation, triple top formation,

double bottom formation, triple bottom formation, etc.,

ü   Continuation patterns are formed during side way movements of share

 price because they indicate a continuation of the trend prevailing

 before the formation of the pattern.

§  Triangle formation is formed when the price movements result in two or

 more consecutive descending tops and two or more consecutive ascending bottoms.

ü  The triangle becomes more apparent on the chart when the consecutive

tops are joined by a straight line and the consecutive bottoms are joined be another straight line.

ü  The two straight lines are the upper trend and the lower trend line

 respectively.

       The triangle formation may occur during a bull phase or a bull phase. In

      either case it would indicate a continuation of the trend.

Triangle formation

ü  Flags formation looks like a parallelogram with the two trend lines

Forming two parallel lines. The volume of trading is expected to fall during the formation of the flag and again pick up on breaking out from the pattern. It is illustrated in the following graph:

Flag formation

§     Pennants formation looks like a symmetrical triangle.

ü  The upper trend line formed by connecting the tops stoops  downwards. 

ü  Whereas the lower trendline formed by connecting the bottoms rises 

Upwards.

Pennant formation

            According to Dow Theory, the market has three movements and these movements are simultaneous in nature. These movements are:

ü  The primary movement is the long range cycle that carries the entire market up or down and is the long term trend in the market.

ü  The secondary reactions act as a restraining force on the primary movement because these are in opposite direction to them and last only for a short while. These are also called corrections

ü  The minor movements are the day-to-day fluctuations in the market. These movements are not significant and have no analytical value as they are of very short duration.

          The price movements in the market can be identified be means of a line chart in which the closing prices of shares or the closing values of the market index may be plotted against the corresponding trading days. The chart would help in identifying the primary and secondary movements. This is illustrated in the following line chart:

Primary trend and Secondary Reactions

     From the above line chart it is clear that the primary trend of the market is upwards, but the secondary reactions in the opposite direction.

            Bullish trend:

ü  The First phase - the prices would advance with the revival of

     confidence in the future of business and the future prospects of the

     business would be perceived to be promising which makes investors

     to buy shares in the companies.

ü  The Second phase - the prices would advance due to improvements in

      corporate earnings.

ü   The Third phase - the prices advance due to inflation and

       speculation.

       The three phases are shown in the following graph:

Three phases in bull market

             The line chart exhibits three peaks. Each peak would be higher than the previous peak; each successive bottom would be higher than the previous bottom. The formation of higher bottoms and higher tops indicates a bullish trend.

                  Bearish trend:

ü  The First phase  - the prices begin to fall due to abandonment of hopes. Investors begin to sell their shares.

ü  The Second phase - the prices fall due to increased selling pressure.

ü  The Final phase     - the prices fall still further due to distress selling.

             The three phases of a bear market are shown in following line chart:

Three phases of bear market

                       A bearish market would be indicated by the formation of lower tops and lower bottoms.

                      Further the Dow Theory laid emphasis on volume of transactions. According to the theory volume should expand along the main trend. This implies that if the main trend is bullish, the volume should increase with the rise in prices and fall during the intermediate reactions. In a bearish market when prices are falling, the volume should increase with the fall prices and be smaller during the intermediate reactions.

                    The theory also makes certain assumptions referred to as the hypothesis of the theory:

ü  The first hypothesis states that the primary trend cannot be manipulated. It means that no single individual or institution or group of individuals and institutions can exert influence on the major trend of the market.

ü  The second hypothesis states that the averages discount everything. It means that daily prices reflect the aggregate judgement and emotions of all stock participants.

ü  The third hypothesis states that the theory is not infallible. The theory is concerned with the trend of the market and has no forecasting value as regards the duration or the likely price targets for the peak or bottom of the bull and bear markets.

Market Indicators:

                   Technical analysis focuses attention not only on individual stock price behaviour, but also on the general trend of the market. Indicators used to study the trend of the market as whole are known as market indicators. Some of them are as follows:

ü  Breadth of the market: by comparing the number of shares which advanced the number of shares that declined during a period, the trend of the market can be ascertained. Comparison of advances and declines is a leans of measuring the dispersion or breadth of a general price rise or decline. The difference between the advances and declines is call Breadth of the market.

ü  Short interest: A speculator often resorts to short selling which is selling a share that is not owned be the person. This is done when the speculator feels that the price of the stock will fall in future. He hopes to purchase the share at a later date below the selling price and reap a profit. The volume of short sales in the market can be used as a market indicator. As a technical indicator, short selling is called short interest. The expectation is that short sellers must eventually cover their positions, this buying activity increases the demand for stocks.

ü  Odd-lot Index: Small investors are presumed to buy smaller number of shares than the normal trading lot of 100 shares. These are known as odd lots and the buyers and sellers of odd lots are called odd lotters. An odd-lot index can be calculated by relating odd-lot purchases to odd-lot sales.

                   Odd-lot index        =         Odd-lot purchases

                                                              Odd-lot sales

            An increase in index    -    suggests more buying activity.

            A decrease in index   -     suggests more selling activity.

Mathematical Indicators:

                      Share prices do rise or fall in straight lines. The movements

     are erratic. This makes it difficult for the analyst to gauge the underlying

     trend. He can use the mathematical tool of

Ø  Moving averages are the mathematical indicators of the underlying trend

of the price movement. Two types of moving average are commonly used by the analysts are as follows:

ü  Simple Moving Average calculates a set of averages for a specific number

of days, each average being calculated be including a new price and excluding an old price.

ü  Exponential Moving Average(EMA) is calculated by using the following

formula:

                EMA = (Current closing price-Previous

                                EMA)* Factor+Previous EMA

Note:     Factor   =   2  

                           n+1

Ø  Oscillators are calculated with the help of closing price data which helps to identify overbought and oversold conditions and also the possibility of trend reversals. These indicators are called oscillators because they move across a reference point. They are of two types:

ü  Rate of Change Indicator measures the rate of change of current price as compared to the price a certain number of days or weeks back. To calculate a ‘n’ day rate of change:

                        ROC =     Current price           - 1

                                     Price ‘n’ period ago

ü  Relative Strength Index is a powerful indicator that signals buying and selling opportunities ahead of the market. RSI for a share is calculated by using the following formula:

                     RSI =100-[100/ (1+RS)]

Note:     RS = Avg. gain per day

                     Avg. loss per day