Against The Gods Essay, Research Paper

Through all the years of stocks, people never thought of defining risk with

numbers. It was never about a definition, but about the feeling in your gut when

you see that your risk was rising. In the world of Stocks there are two types of

people; the ones who stand by risk and the ones who lean on security. The

aggressive and the faint-hearted. The young man, who separated these, weak from

strong, wrote an article in June 1952, to the Journal of Finance. This man,

Harry Markowitz, an unknown 25-year-old graduate student at the University of

Chicago, wrote a fourteen-page article titled ?Portfolio Selection.?

Markowitz was dealing with a subject ?considered too dicey and speculative for

sober academic analysis.? He was writing for the big boys.

Immediately Markowitz decisively pinpoints his objectives, stating that ?an

investor should not select securities based on their individual properties, but

based on how they fit into the whole of the portfolio.? In other words, the

risk of a prospective security is irrelevant to the investment decision, it is

only the degree to which the addition of this security raises the risk of the

portfolio as a whole that should be considered. This is an important

perspective, since it is quite possible for an extremely unpredictable security

to add very little risk to a portfolio when it is "uncorrelated" with

the securities already in the portfolio. In other words, since the individual

securities do not move together, some of the movement of each is "washed

out" by the movement of the others. These happenings are very unreliable to

predict and nowhere near able to control. Stocks, bonds, saving accounts, and

each investor?s returns depend on this, risk. However they are still able to

manage the risks that they take. The higher the risk should in time produce more

wealth, but only for the patient investors who can stand the heat.

Risk was the notation that Markowitz used to construct portfolios for

investors who ?consider expected return a desirable thing and variance of

return an undesirable thing.? The ?and? is the hinge on which return and

variance helps Markowitz build his case. He has decided therefore that risk and

variance have become synonyms. This then brings us to variance and standard

deviation. ?The greater the variance or the standard deviation around the

average, the less the average return will signify about what the outcome is

likely to be.? The market is always unpredictable, this is why investors take

the easy way out and only bet a small bit than bet a larger bit and win more.

They know that they are also capable of losing the larger bit as easily as

losing the smaller bit. In von Neumann?s game of strategy, he says that by

diversifying instead of striving for the kill the investor at least maximizes

the probability of survival.

Efficiency means maximizing output relative to input, or minimizing input

relative to output. Markowitz rather reserves the term ?efficient? for

portfolios that combine the best holdings at the price with the least of the

variance. But what it really means or what we really want to hear is that

efficient portfolios minimize that ?undesirable thing? called variance while

simultaneously maximizing that ?desirable thing? called getting rich. Its

too bad it isn?t that easy. Efficiency is the only loophole in Markowitz?s

article that has to be encouraged by the investors gut feeling.

The stock market is a game. It?s a strategic game that has to be played

knowingly. The market isn?t just a sport that you can manipulate and win

millions on your first try. It?s a way of life. A religion to some. These some

know what gut wrenching risk is. It?s a risk of numbers. An art, which is

followed by each stroke of the brush. A risk of life. A rush that you get when

you?re hurtling down a roller coaster at top speeds. It?s a feeling of

superiority. It?s the smell of sweat, cologne, leather briefcases and freshly

pressed business suits. It?s a whole other world. A utopia. Everything relies

on its turnout. In our daily lives the Stock Market is God.