What is weighted alpha?

Weighted alpha is a metric that evaluates a security’s performance over a specific time frame, often a year, but it gives current activity a higher weight than previous performance.

The capacity of an investing strategy to outperform the market, or its “edge,” is referred to as alpha (α). Because markets are efficient and it is impossible to generate returns higher than the overall market consistently, alpha is sometimes called “excess return” or “abnormal rate of return.”

Recognizing Equivalent Alpha

As its name suggests, weighted alpha is a weighted indicator of how much a security, such as a stock, has increased or decreased over a specific time frame, often a year. By giving later performance measures a greater weight than earlier ones, more weight is usually given to recent activities. This aids in providing a return figure more focused on the most recent time frame, which should be more significant when examining that security. Technical analysts and traders often use analytics to support their trading decisions and are big fans of this indicator.

Weighted alpha calculates an alpha performance number using weighted mathematical operations. A measure of risk-adjusted performance in comparison to a benchmark is called alpha. Alpha is often used in asset management as a stand-in for the fund manager’s ability. This line of thinking may also be applied to stock analysis, which indicates a company’s management team’s efficacy.

For instance, a stock with an alpha of zero would have returns comparable to the benchmark after accounting for the degree of risk taken. When the alpha is positive, it means that the stock outperformed the bar in terms of return, and when it is negative, the opposite is true.

Weighted Alpha Syntax

Weighted computations assign a weight based on multiple variables. Index weighting gives a higher weight to securities based on market capitalization or price. More importance is often given to period returns over a time series that are more recent in a weighted alpha calculation.

Typically, weighted alpha computations concentrate on a security’s return within a year. An investor may often infer that a security’s price has increased over the previous year if it has a positive weighted alpha. Investors might anticipate a poorer one-year price return if a security’s price has a negative weighted alpha.

Weighted Alpha = ∑(W×α)/n, where W is the weight given to each data point, α is the alpha, and n is the number of days in the given time series.

Weights in a weighted alpha computation might change according to the software used for technical analysis or personal preferences. While some weighted alpha computations employ a typical decreasing weight technique, others may allocate weights based on quartiles.

Together with beta (the Greek letter β), which gauges the whole volatility or risk of the broad market—also referred to as systematic market risk—alpha is often used.

Alpha-Weighted Inferences

Many different types of investors employ weighted alpha. Weighted Alpha is the indication that technical analysts most often use to support buy-and-sell recommendations. Using this metric, technical analysts may pinpoint firms with a strong trend over the last 12 months and focus on those with increasing momentum. When weighted alpha is positive, it can support a bullish buy signal. When weighted alpha is negative, it can help a bearish sell signal.

For example, consider a stock that has experienced several highs and lows over the last year through bullish and bearish trending patterns. A technical analyst using a Bollinger Band channel may see the price approaching its support trendline. If the stock has a positive weighted alpha, it can be an affirmation that its price has essentially been gaining over the last year, supporting another bullish push higher.

In another scenario, a trader may see a stock’s price reaching and beginning to exceed its resistance band in a Bollinger Band channel. Often, this is a signal of a reversal and would indicate a sell signal. However, if this security has a positive weighted alpha, it will likely break beyond its resistance level and move higher. Therefore, the weighted alpha could support a buy trade in this scenario.

Conclusion

• Weighted alpha measures the performance of a security over a certain period, usually a year, with more importance given to recent activity.
• A positive weighted alpha shows that the security produced a return more significant than the benchmark; a negative measure indicates the converse.
• Weighted alpha can identify companies that have shown a strong trend over the past year, specifically companies whose momentum is building.