Modern Portfolio Theory

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Modern Portfolio Theory (MPT) suggests that thinking in portfolio terms is better from a risk-return profile than doing so in terms of individual securities. One can use expected returns and volatility of various combinations of securities to determine which provide optimal risk–reward scenarios. These portfolios can be plotted out, creating the efficient frontier. The investor should select a portfolio on that frontier. This can be extended by the use of leverage, leading to the formation of the capital market line and so-called "super-efficient" portfolios.

Most traders — when thought of as speculators rather than investors — do not think in terms of portfolios in this fashion, however.


[edit] See also