Traditional investing: risk vs reward

Data-Driven Decision Making for Business

Ted Kwartler

Data Dude

What is a market?

Traditional markets

Infrastructure where parties exchange goods

  • Stock Markets
  • Bond Markets
  • Housing/Mortgages
  • Commodities: gold/silver etc
  • Crop Futures: corn/soybean
  • Consumer Credit

Supply and demand Supply & Demand

Data-Driven Decision Making for Business

Investment strategies

  • Belief-based investing
  • High-frequency trading
  • Financial fundamentals
  • Technical trading rules
Data-Driven Decision Making for Business

Belief-based investing

Bread lady

Buy the companies you believe will perform well or want to support

  • "I bought stock in my favorite streaming service"
  • "It was so busy last time I was there, I bought stock in my favorite fast food restaurant"
  • "I won't buy stocks that produce tobacco"
Data-Driven Decision Making for Business

High-frequency trading (HFT)

Providing liquidity or taking advantage?
  • Highly automated
  • No human in the loop
  • Need speed, volume, and volatility to succeed
  • Jump you in line and make money on your stock order
  • Requires servers close to the market's data centers

Mainframe

Data-Driven Decision Making for Business

Financial fundamentals

Buy the companies demonstrating financial indicator strength

  • "I bought stock X because they have excellent revenue growth"
  • "I don't care if they are gun manufacturer, their dividend is high."

Genetically Modified Food

Data-Driven Decision Making for Business

Technical trading rules (TTR)

Technical Trader

Trade based on mathematical indications

  • "The MACD crossover is positive for this stock so I bought it"
  • "The relative strength indicator shows a stock is overbought, so I decided to sell"
Data-Driven Decision Making for Business

Capital Asset Pricing Model (CAPM)

Expected return of investment (ER) = 
Risk free rate + (Beta * (Expected market return - Risk free rate))
  • Beta (risk of the investment): how a stock moves with respect to the market
    • Beta between 0-1: stock is less volatile than the market
    • Beta > 1: stock is more volatile than the market
  • Risk free rate: rate of return for an investment that never defaults
    • In practice: 3-month US Treasury bill's interest rate minus inflation
Data-Driven Decision Making for Business

Capital Asset Pricing Model (CAPM)

Expected return of investment (ER) = 
Risk free rate + (Beta * (Expected market return - Risk free rate))

Example

  • Risk free rate =0.03
  • Expected market return = 0.09
  • Beta of stock X = 0.5

ER = .03 + .5(.09 - .03)

ER = .03 + .5(.06)

ER = .03 + .03 = 0.06

Data-Driven Decision Making for Business

Interpreting a CAPM chart

CAPM

CAPM_ZOOM

1 https://www.investopedia.com/terms/c/capm.asp
Data-Driven Decision Making for Business

Data-driven investing!

Data-Driven Decision Making for Business

Preparing Video For Download...