You let the computer pick stocks for you. But not randomly...based on a certain set of conditions (like high yield or low risk, etc.), you’re likely to get a bunch of stocks that share more than just the characteristics of being high yield or low risk. They’ll also likely have other things in common, like being in the same industry or being companies that have similar business profiles or management philosophies.
Attribute bias is the tendency for those auto-selected securities to have more in common than you asked for. Let’s say you decide to use the built-in tool on your trading software that gathers a collection of securities that fit a certain profile you’re interested in (high-earning or stable or low risk, etc.). The bots inside your computer return a whole list that fit the profile to a T. When you go to buy some of those securities, you may be getting more than just a group of stocks that all fit the profile of "stable." You might be getting stable stocks that are all in tech or maybe agriculture or companies that have similar leadership styles.
It isn’t necessarily a bad thing, but it can lead to an un-diversified portfolio.
Related or Semi-related Video
Finance: What is Modern Portfolio Theory...4 Views
Finance allah shmoop what is modern portfolio theory All right
basic idea Here people Diversification is good Dig it right
C d i g there that's modern Alright let's goto
a gn modern like when hunk and invested from their
cave Well they just invested in good rocks or spears
and really didn't worry about much else And well math
hadn't really been invented yet So like who knew that
If all right well then along came harry markowitz in
nineteen fifty two who tried to science and math the
crap out of the stock market What he came up
with was modern portfolio theory which basically said that there
was a smarter way to invest than just you know
putting your life savings into blockbuster because you like the
logo using all sorts of advanced metrics that we won't
torture you with here The theory he devised was that
well rather than throwing your money against the wall to
see what sticks you could use extensive elaborate data to
determine the best way to maximize your returns depending on
how much risk you were willing Teo you know risk
And there are five key ideas behind modern portfolio theory
And yes of course we have videos on each of
these The first is alfa which is kind of like
how smart you are in the market Then there's beta
which is about volatility in a broadway The vics we
got a whole video set on that Then they're standard
deviation and no that's not some kinky reference to fifty
shades It's more about how the market diverges from your
given individual stock pick and volatile things are finally the
beta then there's our squared it's all about how a
stock or a given index conforms to a given line
or expected return ratio Like how close it is how
proximate is And then finally you have the sharpe ratio
Thank you bill sharp from stanford university who also talked
about being smart in the market so that you could
evaluate your rich turns whether they were smart or just
a lottery ticket Lucky Oh and we're probably not such
a wise investment in the beginning even though they turned
out okay That would be sort of the sharpe ratio
Yeah all right Well in general mpt skews toward less
risky investments but it all comes down to risk reward
Tolerance in the end if for whatever reason you feel
supremely confident that radio shack is about to make a
massive come back well you might be able to justify
taking more risk in loading the dice But to be
clear radio shack was just a bad example So kids 00:02:33.29 --> [endTime] don't try this at home
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