How to Find and Profit from High Alpha Stocks

Introduction to High Alpha Stocks

Alpha measures the performance of an investment compared to a benchmark. A positive alpha indicates that a stock has outperformed the market, while a negative alpha suggests underperformance. Alpha indicates the added value of stock beyond what the market is doing.

The content of this article provides actionable strategies and insights to effectively trade high alpha stocks, helping you maximize profits while managing risks.

I’ll answer the following questions:

1. What does the term “high alpha stocks” mean?
2. How do alpha and beta differ in stock analysis?
3. Why are high alpha stocks significant in a diversified portfolio?
4. How can I identify high alpha stocks for trading?
5. What role do technical and fundamental analysis play in finding high alpha stocks?
6. What are the best strategies for trading high alpha stocks?
7. How important is risk management in high alpha stock trading?

Let’s get to the content!

Understanding the benefits of high alpha stocks is key for investors who want to enhance their overall portfolio performance.

Do you have a trading plan yet? If not, watch this video to learn how to build one in three simple steps:

What Does Alpha in Stocks Mean?

Alpha in trading measures a stock’s performance relative to a benchmark index. This measure indicates whether a security has performed better or worse than the market average. A positive alpha indicates that a stock has outperformed the market index, while a negative alpha suggests underperformance. 

For example, if a stock’s alpha is +5, it has outperformed the benchmark by 5%. Conversely, an alpha of -5 indicates a stock has underperformed the benchmarked by 5%.

Assessing alpha helps traders understand their risk-adjusted performance. This insight allows investors to refine their strategies, focusing on securities that add the most value to their portfolios. 

What Is the Definition of ‘High Alpha Stocks’?

High alpha stocks are characterized by:

• Significant outperformance relative to a benchmark index.
• Strong historical returns adjusted for risk.
• High volatility, offering both opportunities and risks.
• High growth potential and innovative business models.

Advanced traders seek out these types of stocks due to their potential for substantial profits. By leveraging the unique characteristics of high alpha stocks, traders can achieve returns that surpass the broader market.

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Alpha vs. Beta Stocks

Alpha and beta are distinct concepts in stock analysis:

• Alpha: Measures a stock’s performance against a benchmark index.
• Beta: Indicates a stock’s volatility relative to the market.

A stock with a high alpha has outperformed its benchmark, reflecting sophisticated stock-picking skills. Conversely, a high beta stock exhibits significant price fluctuations compared to the market, offering both higher potential returns and increased risk. 

The Significance of High Alpha Stocks

High alpha stocks play a vital role in a diversified portfolio. They provide an opportunity for outsized returns, compensating for underperforming investments. By including high alpha stocks, traders can enhance their overall portfolio performance, achieving a better risk-return balance. However, these stocks also come with higher volatility and potential for significant losses.

What Makes High Alpha Stocks Attractive?

High alpha stocks often correlate with market volatility, creating opportunities for substantial gains during market fluctuations.

The Impact of High Alpha Stocks on a Portfolio

High alpha stocks can significantly impact portfolio performance. By enhancing returns, these stocks can improve overall portfolio value. Integrating high alpha stocks into a trading portfolio involves strategies such as:

1. Identifying potential high alpha stocks through technical analysis, fundamental analysis, and sentiment analysis.
2. Diversifying investments to manage risk.
3. Monitoring performance and adjusting holdings as needed.

Identifying High Alpha Stocks for Trading

Identifying high alpha stocks requires a multi-faceted approach that combines various types of  analysis.

Technical analysis helps pinpoint stocks with potential price movements. Fundamental analysis provides insights into a company’s financial health and growth prospects. Sentiment analysis gauges market perception, adding another layer to the decision-making process.

Technical Analysis Tools to Find High Alpha Stocks

We have several technical analysis indicators we can use for identifying high alpha stocks. These tools help traders spot trends and potential breakouts, enabling timely investment decisions.

Moving Averages

Moving averages smooth out price data, highlighting trends over specific periods. In the case of high alpha stock investing, traders use strategies like:

1. Simple Moving Average (SMA): Buy when the stock price crosses above the SMA.
2. Exponential Moving Average (EMA): Sell when the stock price falls below the EMA.

Momentum Indicators (RSI, MACD)

Momentum indicators like RSI and MACD identify overbought or oversold conditions, signaling potential price reversals. Strategies include:

1. Using RSI to buy when stocks are oversold and sell when they are overbought.
2. Applying MACD crossovers to signal entry and exit points.

When using momentum indicators like the RSI for day trading, you’ll definitely want to fine-tune the settings to match your trading style. For instance, adjusting the number of days in RSI can help identify more precise entry and exit points.

Some day traders modify the default 14-period RSI to shorter periods for faster signals. This customization allows traders to react quickly to market changes and optimize trading outcomes. 

To dig deeper into effective RSI settings for day trading, read this explainer on RSI settings for day trading.

Fundamental Analysis in Short-Term Trading

Identifying high alpha stocks entails a lot of fundamental analysis. Evaluation of a company’s financial statements, industry position, and growth potential helps determine its intrinsic value.

Earnings Surprises

Earnings surprises, where reported earnings differ from analysts’ expectations, can indicate high alpha potential. Traders capitalize on earnings surprises by:

• Monitoring quarterly earnings reports.
• Analyzing pre- and post-earnings stock performance.
• Trading based on deviation from expected earnings.

Industry Trends

Industry trends impact the performance of high alpha stocks. Advanced traders leverage these trends by:

• Identifying emerging sectors with growth potential.
• Investing in companies poised to benefit from industry shifts.

Sentiment Analysis

Sentiment analysis evaluates market mood and investor attitudes toward specific stocks. 

Techniques include:

• Analyzing social media and news for sentiment indicators.
• Using sentiment scores to inform trading decisions.

How to Profit from High Alpha Stocks Trading Strategies

Various trading strategies can profit from high alpha stocks but you must match these strategies with your individual risk tolerance and goals to be successful.

Day Trading High Alpha Stocks

Day trading involves buying and selling high alpha stocks within the same day. Key considerations include:

• Monitoring market news and trends.
• Using technical analysis for timely entry and exit points.
• Managing risks through stop-loss orders.

Managing your buying power effectively is also necessary for day trading high alpha stocks. 

The distinction between overnight and intraday buying power can significantly impact your trading decisions and risk management. This difference influences your ability to leverage and manage risks. 

For a comprehensive understanding of overnight versus intraday buying power, read this article on overnight vs. intraday buying power.

Swing Trading with High Alpha Stocks

Swing trading focuses on capturing gains over a few days to a few weeks. Benefits include capitalizing on short-term price movements and reducing exposure to overnight market risks. However, it requires careful analysis and timing to be effective.

Scalping High Alpha Stocks

Scalping involves making numerous small trades to profit from minor price changes. The best strategies include:

1. Setting tight stop-loss and take-profit levels.
2. Using high-frequency trading tools for rapid execution.

Risk Management in High Alpha Stock Trading

Trading high alpha stocks requires risk management. Traders need to employ techniques to protect their capital and minimize losses. Primary strategies include setting appropriate stop-loss levels, position sizing, and diversification.

Setting Stop-Loss and Take-Profit Levels

Effective stop-loss and take-profit levels can help you manage risk. Examples include:

• Calculating levels based on volatility and price patterns.
• Adjusting levels according to market conditions.

The Importance of Position Sizing

Position sizing determines the amount of capital allocated to each trade. Methods include:

• Fixed percentage of total capital.
• Adjusting size based on risk tolerance and market volatility.

Diversification within High Alpha Trading

Diversification spreads risk across different high alpha stocks. Strategies include:

• Investing in various sectors.
• Balancing high alpha stocks with stable assets.

Having a sense of your risk tolerance and knowing how to manage it is a critical piece of a successful trading plan. Watch this video to learn more about risk management.

Best Practices for Trading High Alpha Stocks

Continuous learning from experience and adaptation to market changes are necessary for this — or any — trading strategy. Traders should develop a comprehensive trading plan, backtest strategies, and stay informed on market conditions.

Develop a Trading Plan Tailored for High Alpha Stocks

A trading plan should include:

• Thorough research and analysis.
• Clear strategy selection.
• Defined risk management protocols.
• Regular performance reviews.

The Importance of Backtesting Strategies

Backtesting validates trading strategies using historical data. Steps include:

1. Selecting a strategy and relevant data.
2. Simulating trades based on historical performance.
3. Analyzing results to refine the strategy.

Adapt to Market Changes and Alpha Fluctuations

Adapting to market changes involves:

• Monitoring market trends and news.
• Using tools and resources for timely information.
• Adjusting strategies based on current conditions.

Key Takeaways

• High alpha stocks offer potential for superior returns.
• Understanding and measuring alpha is essential for advanced trading.
• Risk management techniques are crucial for success.
• Continuous learning and market adaptation enhance trading outcomes.

There are a ton of ways to build day trading careers… But all of them start with the basics.

Before you even think about becoming profitable, you’ll need to build a solid foundation. That’s what I help my students do every day — scanning the market, outlining trading plans, and answering any questions that come up.

You can check out the NO-COST webinar here for a closer look at how profitable traders go about preparing for the trading day!

What kind of strategies do you use when you look for stocks to buy? Write “I won’t trade without a plan” in the comments if you’re ready to trade the right way!

Frequently Asked Questions

Is Trading High Alpha Stocks With a Small Budget Possible?

Yes, traders with limited capital can trade high alpha stocks by focusing on fractional shares or ETFs, diversifying their investments, and employing strict risk management.

How Frequently Should I Trade High Alpha Stocks?

The frequency of trading high alpha stocks depends on volatility and individual risk tolerance. Traders should assess market conditions and adjust their trading frequency accordingly.

Can High Alpha Stock Trading be Automated?

Automating high alpha stock trading is possible with advanced algorithms and trading platforms. However, it requires careful monitoring and adjustments to ensure effectiveness in changing market conditions.

What Is The Role Of A Fund Manager?

A fund manager plays a major role in an investment portfolio. The fund manager’s responsibilities include making decisions about asset allocation, selecting stocks, bonds, and other securities, and continually monitoring the portfolio’s performance against benchmarks. They provide services such as financial analysis, investment advice, and risk management to ensure that the portfolio meets the investment objectives.

How Is Compensation Structured For Fund Managers?

Compensation for fund managers often includes a combination of salary, bonuses, and performance-based incentives. This structure aligns their interests with those of the investors, motivating managers to achieve high returns. 

How Do Growth Stocks Impact High Alpha Stocks?

Growth stocks are integral to achieving high alpha in a portfolio. These stocks are expected to grow at an above-average rate compared to other companies. The ability to identify and invest in growth stocks is a key part of generating high alpha, as these stocks can substantially outperform benchmarks over time.

What Are Benchmarks In Stock Market Investing?

Benchmarks are standard measures used to evaluate the performance of a portfolio. Fund managers and portfolio managers use them to assess how well their investments are performing compared to the broader market or specific sectors. Common benchmarks include indices like the S&P 500 or the NASDAQ. 

How Do Interest Rates Affect High Alpha Stocks?

Interest rates have a significant impact on the performance of high alpha stocks. When rates are low, borrowing costs decrease, which can stimulate economic growth and benefit high alpha stocks, especially those in growth sectors. Conversely, rising interest rates can increase the cost of loans and reduce disposable income, potentially dampening stock performance. 

What Is The Relationship Between Crypto And High Alpha Stocks?

Crypto can play a role in a diversified portfolio aimed at achieving high alpha. Cryptocurrencies offer a unique asset class with the potential for high returns, albeit with higher volatility. You should understand the correlation between crypto and traditional stocks in order to manage overall portfolio risk.

How Do Money Markets Differ From High Alpha Stocks?

Money markets and high alpha stocks serve different purposes in a portfolio. Money markets are low-risk, short-term investments that provide liquidity and safety, often yielding modest returns. High alpha stocks, on the other hand, are high-risk, high-reward investments aimed at generating significant returns. 

What Is The Importance Of Asset Allocation?

Investors must employ asset allocation to achieve high alpha in the portfolio. The distribution of investments across various asset classes like stocks, bonds, cash and even credit cards, provides a balance of risk and reward.

What Role Do Taxes Play In High Alpha Stock Investing?

Taxes are a significant consideration for investors seeking high alpha. Capital gains taxes can reduce the overall returns on high alpha stocks. Strategies such as tax-loss harvesting can help offset gains with losses, effectively managing the tax burden on the portfolio.

What Is The Role Of Funds In High Alpha Strategies?

High alpha strategies often use funds as they allow for pooled investments, which enable broader diversification and risk management. Fund managers utilize these vehicles to invest in high-potential equities and other securities. This collective approach helps in achieving higher returns compared to individual investments.

Why Should Investors Understand Finance?

Understanding basic financial principles enables investors to make informed decisions, evaluate risks, and optimize their portfolios. This knowledge is fundamental to achieving high alpha and sustained financial growth.

How Do Various Factors Influence High Alpha Stock Selection?

Various factors, such as market trends, company performance, and economic indicators, play a critical role in selecting high alpha stocks. 

What Is The Importance Of Monitoring Your Investment Account?

Regular portfolio reviews help investors stay aligned with their financial goals and respond to market changes. This proactive approach ensures optimal portfolio management and sustained high returns.

What Is The Role Of Formulas In Financial Analysis?

Formulas in financial analysis are used to evaluate company performance, assess risk, and predict future returns. These mathematical tools help investors make data-driven decisions and identify high-potential stocks. 

How Does Equity Influence Portfolio Composition?

Equity investments form a significant part of a portfolio, offering potential for high returns through capital appreciation and dividends. The proportion of equity in a portfolio depends on the investor’s risk tolerance and financial goals. 

How Does Understanding the Whole Market Benefit High Alpha Stock Selection?

In order to identify trends and opportunities in high alpha stocks, you have to understand the whole market. A comprehensive market view helps investors make informed decisions and anticipate market movements.