Alpha Beta
Stockscores.com Perspectives for the week ending March 3, 2007
In this week's issue:
To beat the stock market, you have to trade Alpha with an awareness of Beta. Let me explain what that means.
Stock price movement, which is really what we care about, is motivated by risk of which there are two types.
First, systematic risk, which is the Beta component. This is the part of a stock's price movement that is outside the control of the company. The correlation of the stock to the overall market is the Beta. Generally, larger companies have a Beta of 1, which means if the market goes up 1% then the stock should also go up 1%. If you compare the chart of Microsoft to the chart of the Nasdaq 100 you will see that they look almost the same. Microsoft is a Beta stock.
Alpha is the part of stock price movement that is based on what the company is doing. It is also called unsystematic risk and is what allows a stock to move dramatically when the overall market is not. Typically, the Alpha component is tied to significant changes in fundamental events.
For the most part, the Stockscores Approach seeks Alpha stocks, those that are moving on their own story and likely to beat the market because they are undergoing significant fundamental change. We try to avoid stocks that are normal, choosing abnormal behavior instead. We recognize that these strong stocks may not be strong for long so we just look to enjoy the run while it is likely to continue and then get out of the stock when the Alpha factor is no longer working in our favor.
The challenge in trading Alpha stocks is controlling risk. Alpha stocks tend to be more volatile because there is more uncertainty among investors. These stocks will jump up in price but could fall just as quickly if the market's speculation turns out to be wrong.
A good Stockscores trader is one that can identify Alpha stocks and eliminate those where the risk is too much for the reward potential. For example, a trade is best left alone if a stock has a great potential to go 25% higher in the weeks to come but could also fall 30% if something goes wrong.
Situations where market activity indicates that the stock is moving on its own story and risk is controllable are what we want to find. Abnormal price and volume action are the best clues that a stock is trading on new fundamentals. Measurable technical support and resistance are what help us understand the risk reward profile of the stock. Our formula for success is to trade Alpha stocks where the risk potential is at least half the reward potential.
But you have to be aware of Beta as well. It is not really significant fundamental change that causes prices to change but, instead, perceptions of significant fundamental change. Perceptions are shaped by emotion and the Beta factor contributes to the emotional make up of the market. Simply put, this means that investors are more likely to be buyers of stocks if the overall market is going up. Alpha stocks will have more upward mobility if the Beta factor is positive as well.
So, when trading, keep these things in mind. Be a more aggressive buyer if the Beta factor is helping. If you want to beat the market, focus on the Alpha stocks that also have good risk reward profiles.
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The market sold off heavily this past week, the worst since September 2001. The confidence of the market is obviously shaken and I think the market is more likely to go lower than higher in the months to come. However, the short term presents a trade on a bounce back that I think is likely to happen next week. What I like about this trade is that if it fails, you will know early and be able to get out with just a small loss. If it works, you should see a decent move to the upside as "bargain hunters" snap up some stocks that were beat up this past week.
For this bounce back trade, I did something very simple. I wanted to look at the most active Nasdaq and TSX stocks to see which ones are coming down to an important level of support and have been sold heavily over the last week. I did a Market Scan on the Nasdaq market for stocks that traded at least 25000 times and then did a similar scan on the TSX for stocks that traded at least 5000 trades in a day. That gave a list of 35 Nasdaq stocks and 14 TSX stocks. I went through the charts of each and a few good swing trade opportunities came up:
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1. LVLT
LVLT remains in a long term upward trend despite this week's sell off and has pulled back to its upward trend line where it should find support. The four day low is $6.20, I think the stock needs to hold above that on the close for this bounce to remain likely. If the trade works, we should see it rally up toward $6.75.
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2. INTC
INTC is not at support yet, but is quite close. I think the stock should be able to hold above $19 on a closing basis in the days to come and then bounce back to move up toward $21. Since the stock is not very volatile, it may be better to leverage the trade with a call option but with about $0.25 of downside and $1.50 of upside, the risk reward trade off is pretty good.
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3. T.DTC
T.DTC made a breakout from a trading range about two weeks ago but then retraced that gain back to $9.50. The stock has good support between $9 and $9.50, I think the trade is to enter here with a very tight loss limit on a close below $9.50. If the trade works, it should bounce back next week to move up toward $10.50 - $11.
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4. T.NT
T.NT has been in a good upward trend since December. After running away from its trend line to start February, the stock has retraced back to it and is now at support defined by that trend line. That is a long winded way to say that it is likely the stock will bounce back in the short term. Bust the trade if T.NT closes below $32.80.
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References
Get the Stockscore on any of over 20,000 North American stocks.
Background on the theories used by Stockscores.
Strategies that can help you find new opportunities.
Scan the market using extensive filter criteria.
Build a portfolio of stocks and view a slide show of their charts.
See which sectors are leading the market, and their components.
Disclaimer
This is not an investment advisory, and should not be used to make
investment decisions. Information in Stockscores Perspectives is often
opinionated and should be considered for information purposes only. No
stock exchange anywhere has approved or disapproved of the information
contained herein. There is no express or implied solicitation to buy or
sell securities. The writers and editors of Perspectives may have positions
in the stocks discussed above and may trade in the stocks mentioned. Don't
consider buying or selling any stock without conducting your own due diligence.
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