Question

Explain how to construct a positive-alpha trading strategy if stocks that have had relatively high returns in the past tend to have positive alphas and stocks that have had relatively low returns in the past tend to have negative alphas.

Answer 1

Alpha is used to measure the performance of an investment in relation to the benchmark index, often expressed in percentages. An alpha of 1% means that the return on investment was 1% better than the benchmark index.

To Construct a positive-alpha trading strategy it would appropriate to buy the stocks that have done well in the past and sell the stocks that have under performed. This is because alpha is an indicator of performance of stocks in relation to benchmark index thus if  the stocks had relatively high returns in the past, they tend to have positive alpas and stocks that had under performed tend to have negative alphas.