EdgeWare FastBreak Standard Version 5 - Manual (Page 90)

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Notice there is a very obvious relationship between return and beta. The thin line is a
trend line of all the data points. You will notice that there is considerable “scatter” in the
data. For example, at a beta value of approximately 1.2, the annual performance for indi-
vidual funds can vary from 19% to over 27%. Alpha ranking has the intent of trying to
purchase the fund with superior performance at a given level of beta. For example, Fast-
Break Pro was used to build an alpha ranking trading system using the funds in the chart.
We then looked at those funds which were purchased most often (five or more times be-
tween 1989 and 1999). We put a second trend line (the thick trend line) in the above
chart for only those preferred funds. Notice that the preferred funds have a higher aver-
age return for a given beta than the average fund.
The usual calculation for determining alpha takes the “correlation” between the fund and
index into account. The alpha ranking we have incorporated in FastBreak is the non-
correlated alpha (NCAlpha) preferred by our users.
The NCAlpha calculation over a ranking period is as follows:
NCAlpha = gain of fund - (
o
fund
/
o
index
)
X gain of index
Where
o
is the standard deviation (volatility). The ratio of the fund and index volatility
is beta.
Note: If the index has a zero gain then NCAlpha is exactly the same as standard rank-
ing.
There are some practical considerations for using alpha ranking. We have found that al-
pha ranking is most useful for trading diversified domestic growth funds. We have not
found it to be useful in trading sector funds. There is the question of which index to use.
The most commonly used index is the S&P 500 (SP-CP in FastTrack), but FastBreak al-
lows any available index or fund to be used. It is not clear how alpha could be used to
trade international funds because of a lack of a common index. We encourage you to ex-
periment.