7.1.11

a zero-sum game

The portfolio theory in investment world talks about investors' attempt at reducing the risk (and if possible, generating higher return) by actually investing in more than one stock at a time. Two or more stocks that are perfectly positively correlated indicate that the expected return of those stocks will move in the same direction at all times. If let's say, the share price of stock A increases, the other (B) would also increase and vice versa. 
On the other hand, a portfolio of perfectly negatively correlated stocks means that the expected return moves in the opposite direction at all times. A risk-averse (and perhaps a rational) investor will tend to form a portfolio of perfectly negatively correlated stocks as an attempt to diversify the risk because in the portfolio of negatively correlated stocks, gain from the increase in share price of stock A would offset the loss from the decrease of share price in stock B. A zero-sum game.
If you and I were stocks in a portfolio, we would probably be the perfectly negatively correlated stocks. We would walk in exactly opposite paths. You would be the rugged and obstinate individual while I'd be the soft and go-with-the-flow kind of person. You'd prefer reading those thriller and mind-bending books while I'd drool over those cheesy hopeless romantic novels. You were strong at Physics while I'd be thrilled by the fact that I barely pass the subject. I would be the exact opposite of where you are and you would too. Thus by not being together, we would benefit our investors, the people other than two of us. Sounds tragic, but that's okay with me so long as we are still somehow connected; because negatively correlated stocks are still correlated, right?

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