Financial markets

Financial assets are made up of securities, stocks and derivatives. These are claims to the cash light generated by real, tangible assets which are the lands, buildings and machineries we use. These pieces of paper are how citizens of highly developed countries increase their wealth. Wealth generation involves risk, for no business activity is certain to turn in returns. Financial marts allow investors to participate in m integrityy-making ventures without being physically present in the project site.Most risk tolerant individuals prefer stocks, for it has the potential to yield precise high returns, while conservative ones go for bonds which provides a steady, fixed income. In this activity, stock trading is the main focus. Objectives Just equal any investor, generating cash meld was the primary goal. The amount of cash to be gained from trading should compensate the risk undertaken. The goal was to achieve steady growth. The expected was return is 40%. After circumstance the required return, a portfolio strategy was chosen.Assets were then selected which would comprise the efficient portfolio provides the highest return for a given level of risk. Fundamental analysis was the method used to resource the stocks. Diversification was another tactic used to maximize return while spreading the risk. Construct a portfolio Portfolio construction was a tedious task. I had to regard the risk and returns, and sometimes, to trust my gut feel. Stock termss, as studies drive home shown follow a random walk movement. The approach used was a top-down portfolio construction. A portfolio is basically a collection of investment assets.The type of assets to be held was first determined. It was then followed by security analysis to pick out the stocks deemed profitable. Diversification was one principle used in choosing the stocks. It simply meant that equities from different industries were held in the portfolio so that risk exposure was limited. Shares from the softwa re industry (RIMM, JAVA), arms(SWHC), pharmaceutical (GERN), computer (PALM), insurance (HUM), wellness care(HMA), power (FL), SAM, metals and mining(AUY, AA) ,oil and gas(IEO), index fund(SWPIX), cement(CX),AXP Asset Analysis Fundamental analysis was mainly used in the decisions undertaken.This approach uses earnings and dividend prospects of the self-coloured, expectations of future interest rates, and risk military rating of the firm to determine proper stock prices. It relies on the unions financial health indicators. The stocks annual growth rate, quarterly earnings records, and P/E (price-to-earnings) ratios were measured. Historical data was also used. wiz such statistic is the EPS, or earnings-per-share ranking. PALM stocks were bought since the firms return on investment was stated at 2470. 70%. Also, on the sidereal day that it was traded, it was lower priced.Smith and Weson, SWHC had a P/E ratio of 5. 50%, an hard roe of 19. 7%. Thus, a total of 4000 shares of SWCH were bought. Alcoa, or AAs ROE was 16. 20%. Its EBITDA was 5. 45 B. Meanwhile, its P/E ratio was 11. 60 and its annual dividend was at . 68 per share. Alcoa looks financially healthy, but was expensive, so only molarity shares were purchased. Similarly, FPLs ROE was 14. 6%. Its P/E ratio was 12. 7%. Its EBITDA was 4. 47 B. The market values FPL shares highly. But, I found it unsmart to invest in highly valued stocks, because market perceptions quiver wildly. Thus, I only acquired 700 shares of FPL.RIMM had an ROE of 30. 60%. Its P/E ratio was 50%. For me, RIMM shares were really costly. In fact, it was has the highest cost per share in my portfolio. But I was attracted to its financial forecast. Further a great deal, its 52 week high was at $148 so I found the $80 per share enticing. I thus bought 1000 shares from RIMM. HUM had an ROE of 19. 9% and a P/E ratio of 18. 00. It was quite overpriced, so I only bought 1000 shares. HMA was the lowest priced stock in my portfolio. But, I stubborn to purchase it believing that demand for health care services will increase in the some future.CX, compared with its competitor, Heidelberg cement had higher(prenominal) earnings and historically displayed returns higher than the market reasonable. I bought 1000 shares. I also bought SWPIX, an index fund as a comparison for the return of my trading activities. Event Selection One of the most remarkable risings was the launching of PALMs Pre. With the belief that the Pre will be hot in the market, just like Apples I-pod, I bought 4,000 shares from PALM. I deem that the future value of PALM will increase more than two-fold once the Pre is introduced. The hype will push the price of its stock.There afterwards, I can sold my shares at a profit. In addition, the popularity of smart phones, or phones which serve more than just talking devices was forecasted to increase steadily in the near future. Aside from purchasing PALM stocks, I decided to buy shares from BlackBerrys coiffer, RIMM. News of the global swine flu outbreak prompted me to purchase HMA shares. HMA , a health care provider would have more profits if the flu would become widespread. In addition, Citigroup upgraded HMA shares from hold to buy. Meanwhile, the crudes on the pending sale of JAVA drove me to con hightail it my 1000 shares.Monster stocks which were identified two weeks in a row included AUY. The information urged me to buy 3000 shares of AUY. Behavioral Finance Even if information processing were perfect, it seemed that investors be towards irrational decisions. In hindsight, these carriageal biases largely affected how I framed questions of risk versus return. Psychologists have found that individuals blame themselves more when an unconventional decision sour out poorly. Based on regret aversion theory, buying a blue-chip portfolio that declines in value is not as painful as experiencing exchangeable losses on an unknown start-up firm.Losses on the blue-chip stock can be more easily attributed to grim luck rather than bad decision. To parry future remorse, I did not include stocks from start up firms. I considered less-well-known firms to be more risky. Even if potential gains can be realized from new firms cod to their tremendous growth capacity and often undervalued stocks, I steered clear from such path. Instead, I trudged towards the tried and tested road and concentrated on well-established companies like Alcoa, Smith and Weson and Cemex, and popular companies like JAVA and RIMM.Availability bias is rooted on the concept that hatful base their decisions on the most recent and meaningful events. The more ongoing or up-to-date the information, the more profound would be its launch on the investor. In the late 1990s, investors got caught up in the internet mania, which caused them to disregard the risks. I suppose that hoi polloi naturally get lost in the moment. In fact, I purchased HUM stocks based mainly on the news that Humana was nam ed top remunerator of pay claims. With the positive publicity of Humana, I projected that its value would also increase in the market, making it an insurance of choice of the public. fit to behavioral finance theories, people are overconfident, especially when they experience success. One main source of overconfidence pointed was that, most individuals consider themselves to be above average in terms of skills. This behavior was apparent when even greenhorn investors experienced exceptional growth in technology stocks of the 1990s. As the stocks continued to climb, investors began to ascribe much of their triumph to their ability to make shrewd investment decisions. Personally, I thought that my projections on the oil and mining industries were more accurate than the foresight of other investors.I thus bought a total of 2000 IEO shares in two different occasions. My rationale was that, oil prices would rise, because it already dipped this year. The same level of smug overconfidence applied to my AUY stock acquisition. In times of crisis, I reasoned, people would splurge on objects which have economic value. In my mind, a woman with money will likely choose a Louis Vuitton bag due to its resale value, than a Prada, even if the former were more expensive. Gold jewelry too, will have high demand, since it can be pawned. Thus, AUY, a gold mining firm was a reasonable buy.Humans have a tendency to seek or interpret information in a way that would confirm ones preconceptions. Conversely, information which contradict prior beliefs would be avoided. This type of selective thinking is called the confirmation bias. With the positive financial data I had gathered about SWHC, I already had a mental picture of its performance. However, since it is mainly an arms company, an industry which I am not well aware of, and less publicized as compared to energy firms, I still had to substantiate my expectations. True enough, the earnings of SWHC grew consistently.The information I needed to verify my previous opinion was made available. I decided to purchase 1000 shares at two different occasions. I bought the first share at $5. 68 and the next 500 at $5. 46. My decision turned out bad, since I decided to sell half of my SWHC shares days later, at a lower price of $5. 29. This action of mine is reflective of the loss aversion theory. It refers to the propensity of people to lean towards avoidance of losing a certain amount than gaining the same value. Losses are considered to have heavier emotional impact than do gains.Observing that the price of SWHC is quite liberation down, I disposed half my shares. I would rather sell at a marginal loss of . 27 per share than wait for the SWHC stock to found deeper than lose much more. However, I decided to keep half the shares. Why? Because I wanted to at least break even with my losses, just in case the price goes up, a behavior quite related to gamblers fallacy. According to the gamblers fallacy, investors liquid ate a position after it has consistently gone up. It is also called the Monte Carlo fallacy.It rests on the belief that deviations from expected behavior which occur repeatedly will eventually be countered by contrary movements. For instance, a huge increase in stock price will eventually be corrected by the market, thus the difference should be employ right away. This belief that high prices are temporary was illustrated in my trading of GERN shares. I bought 4000 shares from GERN at 6. 37 per share. Since the price to book ratio is 2. 02, the stock appeared to be highly valued by the market. But, the return on investment, and EBITDA of GERN is negative, indicating that it is not good for medium term investments.I wanted simply to buy and sell the shares. To take return of its high market value, the 1000 shares of the 4000 GERN stocks were sold at $6. 61. In addition, the news regarding the probability of Oracle selling Sun Microsystems prompted me to sell my shares in JAVA. Ora cles move would mean that JAVA is not performing well. Thus, I had no desire to be part of the lowering of its market value When the news was denote that Palm and Dell lead the technological race,I decided to purchase its stocks. In addition, Palm was about to launch its Pre, a handheld technological device.Palm was a company with huge potential growth, I surmised. I wanted to take advantage of the boom it will undergo once its new product floods the market. Given such information, I bought 4000 shares of the company. Apparently, I wasnt the only investor clamoring for PALMs shares. The market over reacted to the statement that Pre is predicted to be the next It thing. This kind of behavior is called overreaction. According to market efficiency, new information should be reflected almost immediately in a securitys price. For instance, positive reviews should raise a business share price.The new share price should not decline even if no fresh information has been released since. Rea lity, however, tends to challenge this concept. Usually, stock market participants predictably overreact to the most recent information, creating a larger-than-expected effect on the price. In addition, it also appears that this price surge erodes over time. The herding or bandwagon effect simply states that investors move in a certain popular direction. They tend to mimic one another. The huge volume of PALM shares traded enticed me to join in the trend.I had the same mindset with my purchase of IEO shares. The number of subscribers has been increasing since December 2008. Thus, I decided to buy in. Furthermore, on June 1, 2008, IEO was at its 6 month high at more than 900,000 shares. I decided to purchase an additional 1000 shares at $47. 55 . The same theory applied with my purchase of the AUY shares. It was considered hotstock due to its increasing volume in the market. Lastly, the news on CXs reorganization did not entice me to buy its stocks. It announced that it would restru cture its top management effective May 15.But, I only decided to buy 1000 shares two weeks after. I did underreact to new information Expected Return I expected a 40% return for my portfolio. But, I was largely disappointed. The portfolio return was a mere 3%. Since the current risk free rate is at 5%, the asset return is 3% and the standard deviation is . 00334, the Sharpe ratio is -5988. 024 . Based on this calculation, I was not successful as an active portfolio manager. I would have done better if I bought an index fund. My trading performance was largely disappointing. I relied too much on fundamental analysis.I could have used technical data more, to incur larger profits. For starters, I depended heavily on P/E ratios. P/E ratios, it turned out are simply market forecasts, but not highly reliable. Also, I should have taken the risk with undervalued, high growth stocks. These start-up firms could have provided me with returns I could have also used the CAPM, where Re=Rf+(Rm-Rf) B. By comparing a stocks return relative to the market average and risk free rate, I would have a more precise gauge of whether the asset has high yields. Lastly, I wasnt able to observe the market closely for I only traded at night.