Generating Alpha
Originally a thread on X/Twitter:
If you’re an investor in stocks, crypto or NFTs, you’ve probably heard the word “alpha” thrown around.
What is it and does it really exist?
A few thoughts on “alpha” and a specific type of “alpha” that’s been used to generate outsized returns:
It’s important to start with a definition of what alpha is.
Alpha is a measure of the performance of an investment compared with a suitable and equivalent risk-adjusted market index.
In the investment world, alpha refers to the information that you’re able to acquire or act on ahead of the majority of people. This information gives you an “edge” in such a way that you’re able to profit from it.
When someone has a goal to “generate alpha” they’re basically saying that they want to generate a higher return while assuming a similar amount of risk as compared to the benchmark against which they measure their performance.
In the public markets alpha shouldn’t exist. With enough informed participants in a market, all information should be reflected in prices making persistent outperformance difficult if not impossible. Some still remains, but it’s not easy to find or profit from.
But if you participate in any “alpha groups” or “investment forums” you quickly realize that there’s no information asymmetry being shared and no “edge” that creates an outsized profit opportunity. What’s really happening is people shilling their own investments.
When someone “shills” their investment, they do everything they can to convince others to follow their lead. Why? When demand outstrips supply prices naturally increase. Bringing others to an investment can make your own holdings more valuable.
But there is a version of “alpha” that’s always existed and always will exist. And this version of alpha is becoming more and more possible with the increased ability to spin up communities and use social media outlets to coordinate activities.
Generating Alpha
While seeking alpha may be a difficult/impossible strategy to profit from, generating alpha is absolutely possible. In fact, alpha can be manufactured with the right inputs.
One way to generate alpha is to get a “taste maker” or “celebrity” involved. The more active they are, the more their fans and followers will take notice. If they can generate enough demand for a product to move the needle, then they’ve generated alpha.
Collective action can generate alpha because the collective group becomes incremental demand for a product, service, stock, token or NFT.
The larger the buying power of the collective relative to the supply of the item they want to “move”, the more alpha they can generate.
We’ve seen this in action with celebrity brand launches and brand endorsements. We’ve seen this in action with meme stocks. We’ve seen this in action with thinly capitalized tokens. And it won’t be long before we see this in the NFT space.
Some forms of generating alpha aren’t designed to be durable (i.e. – pump and dump) but the concept is a powerful one to internalize.
The ability to spin up and organize communities to act in concert has never been easier…so generating alpha might be the new seeking alpha.
And to be clear….I’m not talking about Insider Trading. Bringing attention to/demand for an item isn’t the same as trading on material, non-public information.