Calmness instead of panicking: a reverse strategy to fight a crocodile attack using downside risk

Abstract

Purpose Heuristics are a less complex and more understandable way to a more straightforward, astute and brisk basic decision-making strategy. The purpose of this study is the development of a rule of thumb called the “Crocodile rule” based on downside risk. Design/methodology/approach The crocodile rule is developed and tested in two steps by using data in the form of stock portfolios of the Pakistan Stock Exchange from January 2000 to November 2017. In the first phase of the study, researchers have forecasted the probabilities, while in the second phase, the researchers have used these probabilities to test the crocodile rule. Findings The findings show the acceptance of the null hypothesis, forecasting error for all categories of stocks for the first phase. The results also show that the minimum recovery chance is 58%, and the maximum recovery chance is 81% with an overall average of 69% chance of recovery. All recovery probabilities are above 50% for all portfolios; this is particularly impressive for a volatile market like Pakistan. Research limitations/implications The study also proposes another performance measure such as “value-at-risk” and compare it with present results to yield better outcomes. Furthermore, other categories of stock like profitability and growth can be tested as well. Practical implications The practical application of this rule is a choice between a “Buy-and-hold” strategy and showing myopic behavior as another extreme. Originality/value This pioneering research focuses on the development of the “Crocodile rule” by using the lower partial moments as a proxy of downside risk. This research adds value to the existing literature on performance measures. Furthermore, it also highlights and indicates which strategy should be used by the investors in case of falling trends in the market.