Portfolio Management - Essay Example

This obviously shows that this theory is not entirely correct. The theory further interpreted shows that investors who thoroughly analyse the market are wasting their time. This theory was coined from the belief that, since the market was often efficient, then it was always efficient. This is however, not always true (Hagstrom, R. 2001, 158). The efficient market theory by Eugene Fama bases its argument on a number of assumptions. First is that all investors rationally seek to maximize the value of their investments.

This means that the information that investors receive on their stock investments can make them react randomly either by overreacting or vice versa. This goes to say that they cannot be predicted or exploited thereof for the purpose of making a profit. Secondly, investors have easy and free access to information and can easily buy or sell stocks without breaking sweat. Third is that, all investors in the stock market are in it to make money. This is true to some extent. Based on these assumptions, one can conclude that all the information that people have that can affect stock prices is irrelevant since it has already affected the price (Hough, J.

2008, 26 -27). Similarly, if the stock price at any one time accurately reflects the value of the company then, stock traders cannot time their trades in a way to take advantage of inside information. Efficient market theory also shows that companies cannot manipulate their accounts to take advantage of investors by manipulating their stock prices. However, market dynamics and IT employ ordinary people who work in various companies neither of whom are consistent or efficient. Nevertheless, cases of companies manipulating their books and insider trading are evident in stock markets around the world (Studymode. 1999, 1). An academic spends time testing viable approaches to the market and comes up with conclusions that a practical player in the stock market will most likely differ with.

This is because an individual practicing in the market will find completely different ways of benefitting from the market. A successful practicing trader in the market is characterized as practical, rational, able to keep their emotions in check and profit oriented (Schwager, J. 2008, 42). There a number of ways that one can benefit from an inefficient market. One is as simple as buying the under-priced stocks and short the overpriced ones. It is obviously a much more complex undertaking than it seems.

Timing and information is any investor’s best asset when it comes to this. As everyone is scrambling to buy stocks and bonds from large companies, one can take this opportunity to target the smaller upgraded companies that others seem to overlook. The stock and bond prices for these companies are sure to be at a bargain since there are fewer players in this pool. One of the most overstated but true investment rules that few seem to follow is to diversify. Diversifying one’s investment portfolio is a sure way to reduce the risk of losses all the while increasing the chances of good returns on investment.

Diversifying however does not just mean investing randomly in different companies. Real application of diversification in investments refers to owning stocks or bonds spread amongst an array of sectors in the market. Diversification does not cost the investor anything and is referred to as free insurance in the