Ever wonder what is the significance of these two Greek letters, alpha and beta to investment? These are terms used in quantitative risk analysis to describe the two main risks inherent in investing in stocks. Alpha relates to factors affecting the performance of an individual stock or the manager's skill in selecting a particular stock. Alpha's movement is independent to the stock market movement and it is normally increasing due to take-over rumours, under strong syndicate manipulation or having strong expectations of good results during results seasons. Whereas, beta relates to market risks, or more specifically, the relative behaviour of stocks. Beta is therefore a measure of how sensitive the price of a specific stock is to changes in the price of the stock market or volatility. A 1.5% high beta stock will probably drop 15% in share price if the market drops 10% while a 10% increase in the market will probably have a 15% increase in the stock. If beta-neutral or zero, the portfolio should be insensitive to swings in the stock market; as such this typed of stock would be hedged. Alpha and beta are used by Investment Managers as a strategy to minimise not only downside risk but also aim to achieve low levels of volatility.We seldom see retailers use these form of analysis as it is time consuming to gather and analyse these data.What the managers do is to perform statistical analysis to rank securities according to their expected returns and risk factors, this is called quantitative risk analysis. From this analysis, they make judgements on stock selection—to enhance alpha and minimise beta risk. The mathematical analysis is usually performed by computer generated models, earning the epithet black box investing.To reduce the sensitivity of stocks to market factors and increase their performance, some modern alternative investment managers also use derivative instruments. On the one hand, derivatives are useful for hedging a portfolio because they allow the manager to set parameters around each investment. On the other hand, derivatives can also be used to achieve leverage, in order to maximise the alpha of the fund.
UOBKayHian summarised some alpha and beta characteristics as follows:
1 Avoid those stocks with negative alpha and prefer stocks with alpha larger than 1 in a volatile market or when the advance or decline of the market is not broadly-based.2 It is better to choose stocks with increasing alpha if you want to trade for a longer term. You, however, have to update your alpha for the stocks regularly.
3 Switch from high alpha to high beta when the market resumes conspicuous trending.
Ng Tian Khean(Alpha-Beta Trading System) provides some good guidelines for the use of Alpha and Beta in trading as below:
1 For very short-term trading, stocks with Beta >1.5 can be regarded as high Beta stocks.
2.Absolute values of Alpha depend on time span of data, and period over which the change is recorded. What is more relevant is the change in Alpha.
3. A stock with high Beta moves up fast when the Index goes up, but also moves down fast with the Index, unless it has a high Alpha value in which case, the Alpha value acts as a support.
4. A stock with high Alpha, but not necessarily high Beta, can move up fast when the Index moves up, if the circumstances for the high Alpha are still present or have increased in influence. This can be depicted as a moving up of the whole regression line, resulting in a higher point of intercept with the Y-axis.
5. Therefore the way to select stocks is to look for changes in Alpha or Beta rather than values of Alpha and Beta. The absolute Alpha and Beta values only show the status quo. To add an element of prediction, the change in Alpha would be more useful.
6. It is better to choose stocks with increasing Alpha rather than increasing Beta. High Beta stocks with low Alpha values require great alertness and usually intra-day trading strategies.
7. The most potentially rewarding stocks are those that have a high Beta as well as a high Alpha; with the added conditions that these values have not peaked,or are already on the way down. This can be confirmed by graphing the Alpha and Beta values.
8. When Alpha and Beta values are graphed, and put on a split screen together with the stock's price line chart, they are seen to be in waves each having a span of between 3-5 days. These waves reflect the inevitable profit taking. But trends and patterns in the waves can also be seen, and these can be analysed using traditional technical analysis concepts of trend, support, resistance and divergence.
9. Generally, a stock is "in play" when the amplitude of its alpha waves are getting bigger while its alpha value is also trending up.
10. Trading short-term with Alpha assumes a trending and reasonably volatile market. In a sideway market, Alpha would not be useful. The determination of market direction and whether it is in a trending stage can be by means of indicators like the ADX and Moving Averages.
11. In a down-trending market, you could either buy stocks with consistently high Alphas for the market's rebound, or,if short-selling is allowed, choose stocks with high Beta and low Alpha.
12. By scanning several markets and seeing which have more stocks with Alpha values at the higher end of the market range, it is possible to select which market to participate in.(A frequency histogram of markets will show which side the values of Alpha are skewed towards).
Confused already, not to worry! As mentioned, retailers seldom use alpha and beta to analyse stocks but rather look into their stock valuations, management and charting etc. These data of alpha/beta are not easily assesible and can be obtained from paid websites like Bloomberg and you need to update them regularly based on your selection criteria. As far as I know, some of the high beta stocks in Bursa Malaysia include Bursa, KNM, WCT and Litrak while the low beta stocks include BJToto, Plus and Tanjong. I am still seeking high alpha stocks(pun intended). I managed to do a search at Bloomberg (stocks MK Equity) and below are some stocks with their correspondening alpha (A) and beta (B):-
2.Absolute values of Alpha depend on time span of data, and period over which the change is recorded. What is more relevant is the change in Alpha.
3. A stock with high Beta moves up fast when the Index goes up, but also moves down fast with the Index, unless it has a high Alpha value in which case, the Alpha value acts as a support.
4. A stock with high Alpha, but not necessarily high Beta, can move up fast when the Index moves up, if the circumstances for the high Alpha are still present or have increased in influence. This can be depicted as a moving up of the whole regression line, resulting in a higher point of intercept with the Y-axis.
5. Therefore the way to select stocks is to look for changes in Alpha or Beta rather than values of Alpha and Beta. The absolute Alpha and Beta values only show the status quo. To add an element of prediction, the change in Alpha would be more useful.
6. It is better to choose stocks with increasing Alpha rather than increasing Beta. High Beta stocks with low Alpha values require great alertness and usually intra-day trading strategies.
7. The most potentially rewarding stocks are those that have a high Beta as well as a high Alpha; with the added conditions that these values have not peaked,or are already on the way down. This can be confirmed by graphing the Alpha and Beta values.
8. When Alpha and Beta values are graphed, and put on a split screen together with the stock's price line chart, they are seen to be in waves each having a span of between 3-5 days. These waves reflect the inevitable profit taking. But trends and patterns in the waves can also be seen, and these can be analysed using traditional technical analysis concepts of trend, support, resistance and divergence.
9. Generally, a stock is "in play" when the amplitude of its alpha waves are getting bigger while its alpha value is also trending up.
10. Trading short-term with Alpha assumes a trending and reasonably volatile market. In a sideway market, Alpha would not be useful. The determination of market direction and whether it is in a trending stage can be by means of indicators like the ADX and Moving Averages.
11. In a down-trending market, you could either buy stocks with consistently high Alphas for the market's rebound, or,if short-selling is allowed, choose stocks with high Beta and low Alpha.
12. By scanning several markets and seeing which have more stocks with Alpha values at the higher end of the market range, it is possible to select which market to participate in.(A frequency histogram of markets will show which side the values of Alpha are skewed towards).
Confused already, not to worry! As mentioned, retailers seldom use alpha and beta to analyse stocks but rather look into their stock valuations, management and charting etc. These data of alpha/beta are not easily assesible and can be obtained from paid websites like Bloomberg and you need to update them regularly based on your selection criteria. As far as I know, some of the high beta stocks in Bursa Malaysia include Bursa, KNM, WCT and Litrak while the low beta stocks include BJToto, Plus and Tanjong. I am still seeking high alpha stocks(pun intended). I managed to do a search at Bloomberg (stocks MK Equity) and below are some stocks with their correspondening alpha (A) and beta (B):-
High Beta 1<
1) Bursa (B 1.7 A 0.025), 2) Sime (B 1.288 A -0.209), 3) CMS (B 1.264 A 0.347), 4) IOI (B 1.113 A 0.67), 5) KLK (B 1.113 A 0.67)
Low Beta 1>
1) BAT (B 0.539 A 0.052), 2) Plus (B 0.705, A 0.07), 3) Public bank (B 0.775 A 0.395), 4) Tenaga (B 0.917 A -0.325)
In summary in a upward trending market, high alpha and beta stocks would perform best. In a down trending market, a higher alpha stock and a low beta stock would be the preferred choices.
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