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Alpha-Beta Trading System (Part II):
Trading For The Risk-Averse

Abstract - This paper describes the design of Select! for Stock Selection

The common image of a conservative and risk-averse stock investor is one who buys Blue Chips and holds on to them forever  But it is not true that the risk-averse cannot trade short-term and compound his gains.  By picking stocks which will outperform the general market and yet are not 'risky', the conservative can trade short term without having sleepless nights  How is this done?

In a previous article ('Making Short Term Gains'), we discussed picking stocks by their Alpha values instead of Beta  To recapitulate, the Beta is the slope of a regression line in a scatter-graph of stock vs index, while the Alpha is the point at which this line cuts the Y-axis.  Non-mathematically speaking, stocks with high Beta, but a low Alpha move up and down with the market sentiment, while stocks with high Alphas are to a greater degree independent of the index.

Fig  9.1  The frequency histogram of the Alpha values of Main Board stocks.

In this article, we show examples of stocks on the Main Board with high Alpha and stocks with high Beta  But first, to prove our theory that in a strong market, more shares will be at the higher range of Alpha values, compare Figs  9.1 and 9.2, Fig  9.1 is a frequency histogram of the Alpha values of SESDAQ stocks and Fig  9.2 is a similar histogram of the Main Board stocks.

 
Fig  9.2  Frequency histogram of the Alpha values of SESDAQ stocks.

In a strong market the Alpha frequency histogram will have more stocks on its right side, while in a weak market, the frequency histogram will have more stocks on the left  From these figures, you can see that both markets are at the moment not very strong, but the Main Board is slightly better than SESDAQ in the sense that it has slightly more proportion of stocks with higher Alpha values.

 
Fig  9.3.  Top ten Main Board Stocks ranked by Alpha.

In Fig  9.3, we rank the top ten Main Board stocks by Alpha, while in Fig  9.4, we rank the top ten by Beta  So Orchard Parade, Wing Tai and Marco Polo are more resistant to downward moves of the index-in this case we used the STII.

 
Fig  9.4  Top ten Main Board stocks by Beta ranking.

On the other hand, UPP, Hong Kong Land and UOB F will move up very fast when the index moves up and also moves down very fast when the index moves down because of their low Alpha values  But look again at stocks with high Alpha as well as Beta such as Marco Polo  They are relatively safe yet relatively fast  Should risk-averse but yearning-to-trade investors pick such stocks?  Of course one must remember that the status quo does not remain forever, that what is strong and fast this week may not be the same next week  Studies like this are therefore to be updated every day  Blue Chips because of their high liquidity usually have high Beta but low Alpha  Fig  9.5 shows the Alpha-Beta graph of UOB Foreign  Note that its Beta is 1.74 while its Alpha is -0.44  The thinner Beta line shows regular swings up and down as profit-taking takes place   Experienced trader's familiar with a Blue Chip's price channel or range of trading can catch it at the bottom of the channel and sell it on the way up.

 
Fig  9.5.  Alpha-Beta profile of a Blue Chip stock.  The thicker line is the Alpha.

In conclusion, it can be seen that in a market there may be some stocks that can offer proportionately more gains without proportionately more risk  These are the stocks for the eager but more conservative investor.