Portfolio Optimization

Abstract

One of the first concepts that a person learns when dealing with the market is that of “Buy Low, Sell High”. In other words, if the trader buys a stock which is expected to go up in price, he will make a profit if he sells that stock later. For example, let’s say that a car company A is planning to build a new factory this year. In a simple interpretation of the “buy low, sell high” concept, it would make sense to buy some stocks of A.We expect that, when the new factory opens, A’s productivity will increase and its stock’s price will go up accordingly.

However, imagine that during the construction of the factory a natural accident happens and destroys it, making A lose much of the time and money invested in that project. A’s stock, which was predicted to go up actually decreases, resulting in a loss to the traders who bought the stock when the new factory was announced (See Figure 7.1).