Hello! ? Last post on stock market volatility, the construction of an investment strategy based on it and its connection with the Markowitz portfolio theory caused a great response among subscribers on Instagram✏️ in that sense, that many asked to tell in more detail about Markowitz's theory.
Markovitsa TheoryMarkovitsa Theory
Therefore, today in #post-weekday I decided to write the essence, Purpose and Application of Harry Markowitz Portfolio Theory ?, who was the first to propose a method of mathematical compilation of an investment portfolio and calculation of the ratio of return and risk, not just a verbal justification for an investment decision. Like ♥ ️ post and increase your investment knowledge!
Nowadays, any #Excel user can create a portfolio based on Markowitz methods ?, who is in the slightest degree familiar with this program. But come up with that, What Markowitz Invented Without Computer Programs, admirable. That is why it passed 38 (!) years since the publication of his theory in 1952 year before receiving the Nobel Prize ? only in 1990 year - in the age of computer technology.
The essence of his theory lies in 2 provisions:
1. Using historical data on stock quotes, the average return and risk is determined (#volatility) for each security.
2. Drawing up a portfolio by selecting shares in it in this way, to: for a given risk, maximize # profitability or, for a given profitability, minimize risk.
The step-by-step calculation of the investment portfolio in Excel will help to understand the essence of the theory. ? It looks like this::
1. #Stock quotes are unloaded. The longer the period, all the better.
2. The profitability of each share for each period of time is calculated, for example, per month. For example, how does it behave stock Gazprom every month, how much does it rise or fall.
3. The average return per share for the entire unloaded period is calculated. Those stocks are removed, the profitability for which turned out to be negative. By the way, this is the flaw in the model, there can be fundamentally good stocks that sank, That, vice versa, you need to buy I will write about this below, because. this is my strategy and this is how it differs from the Markowitz model.
4. The risk for each share is calculated in the same way as in the paragraph 3. For Markowitz, the risk was volatility, ie. price fluctuation. If 2 shares rose the same, but the first of them greatly hesitated, then the risk of the first stock will be greater. Excel has a special formula ? to calculate this risk - standard deviation (deviation of the share price from the average).
5. Using data on monthly stock returns, the covariance between securities is calculated, ie. their relationship with each other. For example, how strongly the growth of Gazprom shares affects the shares of Gazpromneft? Maybe, Stronger, than on the shares of conditional Magnet ? This is necessary in order to, so that Excel can then use the selection method to compose the optimal portfolio in terms of the return-risk ratio.
6. An arbitrary portfolio is compiled as a basis for further calculation. For example, let in the portfolio 3 stock: Gazprom, Sberbank and Norilsk Nickel. Arbitrary shares of each share are given. Let be 40%, 30%, 30% respectively.
7. The weighted average return and risk of this portfolio are calculated. We know the share of securities in the portfolio, average profitability and average risk of each of them (cm. Items 2, 3, 4). Therefore, it is possible to calculate the return and risk of the entire portfolio as a whole..
8. All the previous points were preparation for the main point - the selection of the optimal shares of shares in the portfolio. As I wrote above, one of two objectives is set:
– maximize profitability for a given risk
– minimize risk for a given profitability
Excel has the ability to set such a task ? It's called "Finding Solutions". For example, we need to find such a portfolio structure (share of shares in a portfolio), so that with constant risk there is a maximum profitability. Let the risk (degree of volatility) will 4%, and we set the task to Excel, so that he finds such a ratio of Gazprom shares, Sberbank and Norilsk Nickel, to maximize profitability ? at risk in 4%. And he will find, knowing the average values of the return and risk of each stock and their covariance among themselves.
? You can also set the task to minimize the risk for a given profitability, where the yield will be fixed, and the minimum risk will have to be found by Excel by selecting different options for shares of shares.
? This is how Markowitz's portfolio theory sounds briefly. Again, that a person thought of this without computer programs ? In this post I tried to explain in words, what is the essence of Markowitz's theory.
? In details, the calculation in Excel is clearly and in detail with pictures presented on the BCS website, they have an article "Drawing up an investment portfolio by Markowitz for dummies". Not advertising, and from there he took information for this post, therefore I do not leave links.
There are many flaws in the Markowitz portfolio theory, including the compilation of the optimal portfolio based on historical data on the return and risk of shares. We know, that past performance does not guarantee future performance.
? For me personally, an even more significant drawback of the model is equating volatility with risk. I wrote about this in detail in a previous post.. For me, risk is bankruptcy, decline in market share, default, poor company management, incorrect assessment of the company before purchase, etc.. ? But not a fluctuation in a stock of a fundamentally good company.. If the company is attractive, while its shares are falling, then this is good for me, and I buy in addition. But Markowitz's theory says otherwise..
? My portfolio IIS similar to the Moscow Exchange index in terms of composition. I increase my stock purchases, when the market falls and thus get an advantage over the Moscow Exchange index. If, according to the Markowitz method, we calculate the profitability and risk of my IIS and the Moscow Exchange index, then it will turn out, that both parameters of my portfolio are ahead of the index ? But their composition is the same (I exaggerate)! Yes, volatility is high in my portfolio, but that doesn’t mean, that the portfolio is more risky in terms of investment ? This, perhaps, main idea of this post.
