FXTM information and reviews
FXTM
95%
OctaFX information and reviews
OctaFX
94%
XM information and reviews
XM
93%
FXCC information and reviews
FXCC
92%
FxPro information and reviews
FxPro
91%
HFM information and reviews
HFM
89%

What do alpha and beta mean in investing?


Alpha and beta are indicators for evaluating the effectiveness of investments. Alpha measures the performance of an asset or a portfolio relative to the market. Beta measures volatility, i.e. market risk. Both indicators are historical, meaning they depend on the chosen period and do not guarantee results in the future. Let’s consider them in more detail.

What is portfolio beta?

The traditional approach to investing is based on the modern portfolio theory, proposed by Harry Markowitz in 1952. To achieve an optimal portfolio, use a combination of instruments with a weak or negative correlation. Profits from some assets might offset losses from other ones. The beta coefficient is just what you need to assess the risk. It was first introduced by William Sharpe in 1964.

Beta gives an idea of ​​the capriciousness of the price of an individual asset or the entire portfolio relative to the benchmark. The benchmark is usually a stock index for the broad market. For US stocks, the beta is measured relative to the S&P 500 index.

Beta indicates whether the investor has taken on increased risk relative to the broad market.

Here is how one can interpret the beta values:

Negative beta is relatively rare. You can find beta calculators on the internet.

What is portfolio alpha?

Portfolios often perform better than expected. This excess return is due to the effect of portfolio management - alpha. For example, it could be that the investor correctly determined the entry point and bought the asset at the very bottom. The question is how to separate the investor action factor from the risk premium. Excess returns could also be the result of taking on more risk.

In 1968, Michael Jensen introduced a formula for calculating the risk-adjusted excess return of a portfolio. You don’t need to memorize it.

You can find online calculators on the Internet.

Jensen’s alpha = pr − (rf + b × (rm − rf))

Higher positive alpha values are a good sign. It means that a portfolio manager has picked the stocks correctly. By contrast, negative alpha suggests the investor fell short in achieving the required return. When the alpha is equal to zero, it means that the portfolio manager has earned a return adequate for the risk taken. The alpha indicator is especially valuable for portfolio managers, as it allows for evaluating work effectiveness.

When calculating alpha, one can also assume the results of other investment factors besides betas, such as dividends or cost factors.

The beta allows you to assess the risk of an investment and understand how volatile an asset or portfolio is as a whole compared to the market. In Markowitz’s portfolio theory, the market is efficient, and the greater the risk of an investment, the higher the expected return. But in reality, beta is unpredictable, and stock returns can be even lower than the risk-free rate. From 2000 to 2009, investors suffered losses from US stocks, which performed worse than bonds and cash.

How can one create a smart investment strategy?

Alpha allows you to measure excess returns relative to a risk-adjusted benchmark. It reflects the successful investing actions together with the well-chosen transactions’ timing. An investor should evaluate the beta when drawing up a strategy to understand the risk of investments and enhance the expected return.

As for alpha, the factor is crucially valuable for professional portfolio managers, but simple investors don’t need it. For example, if an investor buys indices and holds them.

#source

Share: Tweet this or Share on Facebook


Related

Mastering Market Liquidity: What Is It And How To Make Use Of It
Mastering Market Liquidity: What Is It And How To Make Use Of It

The term "liquidity" is constantly being tossed around in the finance industry, but what exactly does it mean? Today, we will explore the concept of liquidity, its importance in trading and investing...

Demo Account: Why It's Needed and How to Open It
Demo Account: Why It's Needed and How to Open It

A demo account in online trading is a tool that allows beginner traders to gain experience in financial markets without risking their real money. It is a type of account that mimics the trading conditions...

Forex Trading Sessions: Types And Features
Forex Trading Sessions: Types And Features

The schedule of forex trading sessions allows the trader to determine the best time to start working. During different sessions, the volatility of assets changes: increases or decreases...

A Beginner’s Guide to Bonds – How and Where to Buy and More
A Beginner’s Guide to Bonds – How and Where to Buy and More

Besides forex and stocks, bonds are another popular class of securities that attract many investors. In fact, bonds are traditionally a core component in many types of portfolios, most famously in conservative strategies...

How to Become a Professional Trader?
How to Become a Professional Trader?

After learning more about the world of trading and getting real money from your trades, you might start thinking about becoming a professional trader. But what makes a professional trader?

MetaTrader 4 vs MetaTrader 5
MetaTrader 4 vs MetaTrader 5

The MT4 and MT5 platforms are two of the world’s leading trading platforms, used by a majority of traders worldwide. Released by MetaQuotes in 2005, MetaTrader 4 has gone on to gain widespread popularity...

FXCM information and reviews
FXCM
87%
RoboForex information and reviews
RoboForex
85%
MultiBank Group information and reviews
MultiBank Group
84%
Libertex information and reviews
Libertex
83%
Vantage information and reviews
Vantage
83%
FP Markets information and reviews
FP Markets
81%

© 2006-2023 Forex-Ratings.com

The usage of this website constitutes acceptance of the following legal information.
Any contracts of financial instruments offered to conclude bear high risks and may result in the full loss of the deposited funds. Prior to making transactions one should get acquainted with the risks to which they relate. All the information featured on the website (reviews, brokers' news, comments, analysis, quotes, forecasts or other information materials provided by Forex Ratings, as well as information provided by the partners), including graphical information about the forex companies, brokers and dealing desks, is intended solely for informational purposes, is not a means of advertising them, and doesn't imply direct instructions for investing. Forex Ratings shall not be liable for any loss, including unlimited loss of funds, which may arise directly or indirectly from the usage of this information. The editorial staff of the website does not bear any responsibility whatsoever for the content of the comments or reviews made by the site users about the forex companies. The entire responsibility for the contents rests with the commentators. Reprint of the materials is available only with the permission of the editorial staff.
We use cookies to improve your experience and to make your stay with us more comfortable. By using Forex-Ratings.com website you agree to the cookies policy.