When I started my journey in the stock market 10 years back, then I was unsure which things you should analyze before narrowing down your buying priorities. Over the course of time, I learned a lot many things which were never taught in the classroom. Guess that comes with time & experience. But when I’m here then you need to worry friends I’m here to make your journey a little easier which was not so possible a decade back. In this series, we are going to cover “What is Alpha and Beta in Stock Market? and ” What is their significance in the technical analysis?
What is Alpha and Beta in Stock Market?
We are aware that stock markets are full of risk. Trading stocks is more or less similar to gambling. At the same time, they promise comparable high returns. Everyone wants to maximize their returns while minimizing their risks. That’s how you determine the success of the investment.
As a result, risk and return are two important factors that stock market traders consider. These ratios determine the likelihood of success. Here are two examples of such ratios, which are part of technical analysis and forecast using previous trends and patterns:
Also Read What is Leverage in Stock Market?
Alpha is a metric that measures the success of your investment. It determines how much a stock or fund outperforms the overall market. This is based on the principle that when the market rises over time, it adds value to the majority of stocks. This is known as market return, and it is frequently adjusted for risk. However, many stocks outperform, usually as a result of higher earnings. Their return outperforms the market. This difference arrives by comparing your stock or fund to a benchmark index. As a result, it represents how much value has been added or subtracted from total returns.
Therefore, a stock or fund gets a positive or negative alpha value, denoted by a single or double-digit value. A positive alpha value indicates outperformance, while a negative alpha value indicates underperformance. A positive alpha of 3.5 indicates that the stock outperformed the index by 3.5 percent. As a result, every investor is ‘looking for positive alpha.’
Reading a stock’s alpha is important because it indicates the likelihood of future success.
On the other hand, beta indicates volatility or risks involved. Beta also gets derived by comparing it with the benchmark index. It measures the price volatility of a stock and represents positive or negative figures. A stock with a positive beta value moves in the same direction as the index. A negative value indicates that the stock is moving in the opposite direction, that is, it is rising when the market is falling and vice versa. Furthermore, a beta value greater than one indicates that the stock is more volatile than the market. For example, if the beta value is 1.1, the share price is more likely to fluctuate by 10% than the index. A value less than one indicates that the stock price does not fluctuate as much.
Alpha vs Beta in Stocks
Based on past performance, investors can use alpha and beta to analyze the return and volatility of an investment.
Using historical market data, beta calculates how volatile stock or portfolio is in comparison to a benchmark index. Beta is based on a value of one, with a value of one indicating that an asset or fund will move exactly in line with the benchmark’s gains and losses. Anything greater than 1 indicates that the fund is more volatile than the benchmark, while anything less than 1 indicates that its performance has been more stable in relative terms.
Meanwhile, alpha measures an asset’s return in relation to a benchmark. Based on a value of zero, a positive alpha value indicates that investment has produced returns that have outperformed the benchmark – in other words, the asset’s volatility risk has paid off.
There are no standard alpha or beta preferences within investment markets because investors have different attitudes toward risk or volatility.
Used together, alpha and beta can let investors know whether or not they have been – or are likely to be – adequately compensated for an asset’s volatility risks.
Important to note, however, is that alpha and beta are calculated based on historical market data, meaning they are no guarantee of future returns or volatility.