You may have certainly heard mentions of ‘alpha’ and ‘beta’ during the course of your stock market research. You may even have an inkling that they pertain to technical analysis of the market and are useful tools for the informed investor. But exactly what does alpha and beta mean in stocks? Here’s what you need to know about these indicators as well as the crucial differences between them.
What is Alpha in the Stock Market?
In order to get a better picture of the differences between the two, let us first understand what is Alpha and Beta in stocks. Reviewing both of these concepts are certain to add value to your stock investment decisions and will help clarify the specific distinction with respect to alpha vs beta stocks.
Let us start off with understanding Alpha in terms of stock investment. Simply put, the alpha of a stock is a measure of the return on a stock investment as compared to a benchmark, such as an index. It essentially indicates the active return that is gained as a result of the stock’s performance after being adjusted for volatility and market fluctuations.
The alpha measure in stocks is represented by a single figure and can be either positive or negative, depending on the stock’s performance. The exact value of the alpha represents the percentage by which the stock’s performance deviated from the benchmark. So, if the stock performs better than its benchmark value, its alpha is represented in the positive with a number that indicates the percentage by which it outperformed the market. Meanwhile, a negative alpha indicates the percentage by which the stock underperformed.
What is Beta in the Stock Market?
Moving on in the discussion of alpha vs beta investing, let us take a look at the concept of beta as it relates to the stock market.
Beta coefficient, or as it is more commonly known – beta, is an indicator of the volatility or relative risk of a stock as compared to the entire market’s performance. This measure of volatility can offer crucial insight to an investor about whether the risk of investing in particular is higher or lower than the benchmark.
Like alpha, beta is also expressed in simple numerical figures, both positive and negative. It also resembles alpha in that it actually represents a percentage to show how much more volatile that stock is as compared to the market. The figure indicates whether or not the stock value is moving in the same direction and to the same degree as the benchmark. The baseline for beta is one, and any positive value would indicate that the stock price is moving as per market movements while negative values indicate the opposite.
What are the Differences Between Alpha and Beta Stocks?
As we review these two concepts and discover what is alpha and beta in the stock market, let us take a look at the differences between them.
The primary difference in alpha vs beta stocks investing is that of purpose. While both of them are technical analysis indicators, each of them is used for different reasons. Alpha indicates the degree of a stock’s return with respect to a specific benchmark and is hence more focused on the direct rewards gained through investment. On the other hand, beta indicates the systematic risk or volatility associated with a stock.
When it comes to the question of what is alpha and beta in stocks, it is not a question of which of these two indicators is more useful. Rather, it is more a matter of what the requirements of the investor are and how he plans on using alpha vs beta investing to achieve his investment goals.
For instance, if an investor recognises that there is mispricing and inefficiency currently in the market, he can go for high-risk funds that he believes would offer high alpha over time. On the other hand, a more low-risk investor would choose to go with a stock investment that offers low beta values since they would offer less volatility than the market as a whole.
For the research-oriented investor, knowing what is alpha and beta in the stock market can prove to be a favourable tool on his side. Alpha vs beta investing can not only help you make the right investments in the stock market, but can also be useful indicators for entering and exiting the market. As is the case with all forms of market-oriented technical analysis, it is crucial to do your fair share of research before relying on these indicators for your investments.