Investment decisions should be based on solid analysis. Two of the many methods available to base your decision upon are 'return' and relative strength momentum as analyzed with an 'alpha' formula.
'Return' sounds pretty straight forward and is popular. In fact many chart programs are in effect illustrating the return of a ticker symbol simply by showing the movement of the ticker's price. Either it is going up or down or perhaps gyrating nowhere. But normally there is a percentage change almost every day and if you bought and sold on this basis it would be easy to calculate your return just as you can calculate the return from previous days or history.
'Alpha' on the other hand is best used to try and predict the future movement of a stock, mutual fund or ETF.
Let me explain.
If you analyze a particular symbol that is part of a group of symbols using 'return' over a particular time period you will quickly and quite simply see which symbol has outperformed the others. You can take this a step further and say that the symbol with the best return for the past 10 or 30 days out of your group is the one to now buy. Investing in this manner can be very successful as the analysis indicates which symbols have the greatest growth or loss rate.
The difference between 'return' and 'alpha' is that 'alpha' is calculating not just the progress of the ticker symbol over your selected time period but it is comparing that progress, the change, to a benchmark like the S&P 500 and to all the other symbols in the group, and, most importantly, it is factoring in the rate of change and comparing this rate of change between all of the symbols in the group. In other words, 'alpha' is saying symbol X is moving at a more rapid pace than any of the other symbols and its pace also differs from the benchmark more than that of the other symbols in the group.
This concept of relative strength momentum analysis, of which 'alpha' is one means of calculation, can be used to predict changes. Because the analysis, or predictions, are calculating the relative differences between the ETF or stock symbols in your group the potential for accuracy and stronger profits are greater.
Personally, I have used 'alpha' as my favorite means of analysis for many years. But recently I decided to test 'return' to see which one would produce the best results. I ran tests from 1999 and from 2005 to the present. You might say I did a test drive to see if another model car would outperform the car I own.
Quite frankly I was amazed at the great results, the superb performance provided by 'return', especially when I incorporated a Market Exit signal into the analysis to pull me out of the markets when the S&P 500 was tanking.
However, the 'alpha' test drive still outperformed the 'return' and you might say, let it eat my dust. So I am sticking with my 'alpha' method of relative strength momentum analysis.
Author Raymond Dominick is the designer of Dynamic Investor Pro investment software for stocks, ETFs and mutual funds. He has been investing in the markets since his teenage years. An experienced business manager and journalist, he has been a registered investment advisor representative, also a professional photographer who loves escaping to the wonders of Glacier National Park in Montana. View his software at: http://www.dynamicinvestorpro.com
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