How To Estimate The Portfolio Range
When you have the values of the annualized variance and the annual expected return you can use them to estimate the range in which in most likelihood the returns of your portfolio will vary over the next year. The range will give you a lower and an upper limit and your return will mostly be in this range.
The upper range is calculated by adding the annualized portfolio variance to the annual expected return. The lower bound is calculated by deducting the annualized portfolio variance to the annualized expected return.
Portfolio optimization is important. It lets you add different weights to each stock based on their risk and return expectations. The weight of investment will vary and also will be its returns. Each return on your portfolio will carry with it some risks and so when you vary the weights the risk as well as the return of the portfolio fluctuates.
How do you divide the weight?
Suppose you had a portfolio that had N number of stocks. So how would you be optimizing this portfolio? Would you just look at the past information and identify how much you should be investing into each of these stocks. Is that the way you will be able to make the best returns?
Portfolio optimization is doing just that. You adjust the weight that you allocate to each stock in your portfolio and make sure that the stocks are weighted in such a way that you achieve the best return on your portfolio and that you are exposed to the least amount of risk.
What is the minimum variance portfolio?
Suppose that you have a portfolio that has 10 stocks. You can now adjust the weights based on the return that you desire. The result is basically a characteristic of both risk return on your portfolio. Each of the unique weights allotted will form a different portfolio.
The number of combinations that you can make is many and each of the combinations will include some risk and returns on your portfolio investments.
Among the various combinations, there will be a set where the risk is the least. Thus you need to look for a possible combination where the portfolio variance is minimum. This is known as the minimum variance portfolio and this is the least amount of risk that you can form for your portfolio. The method is highly suitable for those who trade on the automated trading robot and are averse to risk.