Is there a pure-ALPHA?

Posted on May 15th, 2008 by silvia.
Categories: Derivatives.

Basics:

1. -Investing has attached two types of risk: the risk specific to the underlying you invest in and the market risk.

2. Therefore, we have also 2 types of returns corresponding to each risk.

Key points to keep in mind:

1. The first risk decreases as you are investing in more underlyings meaning: The Power of Diversification.

2. The breakdown between the two types of return is identified through:

Stock Return = alpha + (beta x market return)

For the story above:

Alpha = the return earned for accepting exposure to underlying-specific risk. Alpha is theoretically uncorrelated with with beta.

Beta = the measure of an underlying exposure to the overall risk of investing in the specificmarket. An underlying with a beta <1is less risky than the overall market and vice versa . The market itself has a beta =1.

The specific risk can be diversified and this means that the return associated with accepting it must be zero for the market as a whole so in this case we are left with the beta return over the market.

And now the interesting part: the trend to separate beta from alpha investing.

Example: X uses index futures contracts to obtain exposure to the beta risk and return of a given asset class. Futures contracts can be bought for less than their face value so X spends Eur20 to obtain $100 of exposure to the, let’s sat ABC Index. The rest of EUR80 X invests them with a manager that is focused on providing “pure alpha”., meaning that, the manager tries to eliminate the exposure to beta risk (and beta return), leaving just alpha risk and return. How can the manager accomplish this: by selling short the relevant index futures contract, or by offsetting long and short positions in different stocks.

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Trading Rules

Posted on May 3rd, 2008 by bear.
Categories: Technical analysis.

I just read some technical analysis materials and I’ve decided to share their “wisdom” with you. What I’ll realy try to do is to summarize some trading rules that I found very interesting in order to improve one’s portfolio management.

  1. Cut your losses;
  2. Let your profits run;
  3. Never average you losses;
  4. Wait for a clearly defined situation;
  5. Never try to compensate a loss;
  6. Stick to your own style and strategy;
  7. Avoid emotions and analyze everything;
  8. Never trade on figures - market discounted them already;
  9. Don’t be a hero - always question yourself and your abilities;
  10. Be flexible - expect the unexpected;
  11. Use intelligent stops and lock in a profit as the trend continues;
  12. Look for trading opportunities which are not too much observed;
  13. Never bet everything on one trade.

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