Difference Between Alpha and Beta in Stock Market

This happens when an atom does not have a lot of protons but has a bit too many neutrons. After having a little understanding of the alpha and beta meaning, it is important to understand its difference. Depending on the performance of the stock, the alpha measure is a single number that can be either positive or negative. Low beta stocks are those that carry a beta value of less than 1.0. Beta is one of the significant coefficients for investors to analyze securities before investing. For instance, company X has a beta of 2.08 and company Y has a beta of 1.04.

Investors are generally concerned of what do alpha and beta mean in investing. A passive investor places a bet on beta and has little faith in the illusive alpha, whereas an active investor places a wager on his capacity to produce the alpha. Reviewing both of these ideas will undoubtedly enhance the worth of your stock investment choices and help make clear the precise difference between alpha and beta companies. Beta value of securities is one of the significant coefficients investors analyse before investing. It helps individuals analyse the unsystematic or market-related risk related to a company, thereby indicating the level of interdependence between the two parameters.

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During periods of a boom when the stock market is soaring, the high beta value of stocksis expected to generate manifold returns. On the other hand, a downswing of the share market can lead to substantial losses, as a fall in the value of benchmark indices can have an adverse effect on beta stocks. Beta less than 0 – Securities with a negative beta depict an inverse correlation with the stock market. In simpler terms, this means that if the stock market rises, the prices of such securities might fall and vice versa. Gold is a common example of a security whose beta is usually negative.

• If the given value of alpha is positive 2.0, then it means that XYZ has outperformed its benchmark index by 2% and given 22% as returns for that specific year.
• Reviewing both of these ideas will undoubtedly enhance the worth of your stock investment choices and help make clear the precise difference between alpha and beta companies.
• Here, the market usually refers to the benchmark index the fund follows.
• You would need to look at the funds you are considering and evaluate how the returns in the past relate to the Beta values.
• Knowing that you have high beta stocks in your portfolio also tells you that your portfolio is more prone to risk and fluctuation.

If you are a trader looking for stocks that fluctuate a lot, then you can trade in high beta stocks. Knowing that you have high beta stocks in your portfolio also tells you that your portfolio is more prone to risk and fluctuation. Beta measures the volatility of a stock compared with the volatility of the market as a whole. A high beta means the stock price will move faster than a stock with low beta. High beta means high volatility, but also the possibility of high returns. You can see that in the same fund category, there can be significant differences in Beta.

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Not all high beta stocks can earn high returns; similarly, not all low beta stocks produce less than satisfactory returns. It measures only systematic risk, i.e. the risk related to the market. There are other unsystematic risks like a company having high debt, slow consumer demand, losing a lawsuit, etc. Such risks also affect the stock price movements even if the market is going up. If a company is in a downtrend for a few months and the beta is very high then it may be able to have a positive impact but most probably not.

Beta stocks are referred to highly volatile securities, having a high degree of responsiveness to all market fluctuations. With eight years of experience as a Content Strategist, I’ve had the pleasure of working with a Fortune 100 company and building three successful startups from the ground up. As an investment fanatic, I’ve dabbled in early-stage startups, mutual funds, gold, stocks, smallcases, and real estate to identify which assets generate the highest ROI.

It is also true that puts on stocks and selling forward contracts against indices will have negative betas. Beta is a measure of market risk, which cannot be reduced by diversification. In other words, it is that part of the return from the portfolio that’s attributable to the broader market and not the fund manager or investors’ skill. Alpha is a measure of outperformance of a fund given its Beta. Both are part of the total return or total risk of any investment portfolio, and hence, both are needed to be considered for any effective investment. You can also use Beta to evaluate your mutual fund selection by comparing it with other funds in the same category.

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Where Covariance denotes the return on a specific stock relative to the market. By multiplying the beta value of a stock with the expected movement of an index, the expected change in the value of the stock can be determined. For example, if beta is 1.3 and the market is expected to move up by 10%, then the stock should move up by 13% (1.3 x 10). Beta forms the core of the CAPM, which is used to calculate the cost of equity, which is an important input for valuation of a stock. Higher the Beta higher is the compensation that investors will expect from the stock and vice versa.

Beta is based on historical data and enables you to understand the fund’s past performance in relation to the market or its benchmark. As an investor, you deal with market risk by ensuring diversification in your portfolio. Both Alpha and Beta values assess two distinct but equally significant aspects of an investment. However, if you want to pick one over the other, it comes down to your priorities as an investor.

These securities have a parallel effect on a share price and its ROE with market fluctuations in a similar manner when compared to a benchmark index. Large-cap companies have a beta value of 1, as it is the primary constituent of major benchmark indices operating in the country. The beta of Indian stocks less than 1 label an investment venture as relatively stable, as the fluctuation of returns generated are not massively affected by variations in the stock market. Stocks should not be judged solely on the basis of one metric. As an investor, you must holistically view a stock, look at fundamentals and technical, analyse all metrics, ranging from alpha to beta and then make a decision.

A Beta of 1.23 means that; a 1% move in the index will result in a 1.23% movement in the stock price. Beta is calculated not on the price or the index values but on the daily price returns versus the index returns. Normally, the Beta is calculated by considering price data for much longer periods of time so that the vagaries of the market can be avoided.

Beta of a share’s return responds according to swings in the market return. 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. All investors, new as well as experienced, rely on thorough market research while constructing an investment portfolio.

It is also similar to alpha in that it shows how much more volatile a stock is than the market by way of a percentage. Beta is a numerical value and can be equal to, greater than, or less than 1. Stocks with a beta value higher than 1 are considered high beta stocks, whereas those with less than 1 are considered low beta stocks. As discussed above high and low beta, it justifies the riskiness of stock plus a very low beta or a very high beta can be detrimental for the investors.

Each WealthBasket is based on an investment strategy or idea, which leads to selecting stocks and ETFs accordingly weighted to generate returns for an investor. Alpha can show how a share or investment will perform compared to its competitors or the overall marketplace. Beta measures the volatility in financial markets, which can assess risk exposure in an investment. For example, if you are holding on to steel stocks in your portfolio and the risk is high because the steel cycle is going down then what do you do? The steel cycle will impact steel stocks but will not have a major impact on a FMCG stock. Hindustan Unilever and Britannia are not really worried about whether the global steel cycle is turning up or down.

Some zero-beta assets are risk-free, such as treasury bonds and cash. However, simply because a beta is zero does not mean that it is risk-free. Values of Beta for equity funds can be more than 1 or less than 1. While positive Beta funds play a huge role in growing your investment, negative Beta funds have a role in asset allocation and balancing the risks in your investments.

Low can beta be negative stocks are more stable in comparison to high beta stocks but may offer low returns. Sometimes they rise, signalling a profit, while sometimes they plummet down, causing a loss. The volatility risk cannot be avoided while trading in stocks as different stocks have different volatilities.

• The Zero-Beta Portfolio is created in such a way that has no systematic risk.
• Each is determined utilising the base equity’s past performances.
• Gold is a significant example of such investment tool having a negative beta, as its value tends to rise over time.

Alpha value compares the overall return of your investment to the gross return of a baseline index. On the other hand, Beta evaluates how unpredictable a given asset is compared to a baseline index. When comparing mutual funds, the Alpha value is frequently employed. Suppose you understand how a particular mutual fund has done historically compared to a baseline index. In that case, you may use the Alpha value to determine if the fund outperforms or comes up short.

The research, personal finance and market tutorial sections are widely followed by students, academia, corporates and investors among others. Beta is the key factor used in the Capital Asset Price Model which is a model that measures the return of a stock. The volatility of the stock and systematic risk can be judged by calculating beta. A positive beta value indicates that stocks generally move in the same direction with that of the market and the vice versa. A high alpha means a strong stock and a negative alpha could indicate a weak stock.

Usually, small-cap and mid-cap companies have a beta value of higher than 1 on their respective stocks, as their potential for growth is extensive. Purchasing stocks or bonds of such businesses can lead to substantial wealth accumulation through significant annual returns. Individuals can enjoy such returns through dividend pay-outs or capital gains through a resale at a later date. Alpha measures the additional/excess returns a stock or a security yields over and above the benchmark returns. Alpha and beta are both used to analyse stocks when measuring their inherent risks and returns.

A positive beta value means that the stock moves in the same direction as the index. A negative value indicates an opposite direction, that is, the stock rises when the market falls and vice versa. Also, a beta value over 1 means the stock is more volatile than the market. For example, if the beta value is 1.1, the share price is like to swing more by 10% than the index. A value lower than 1 means the stock price does not fluctuate as much.

Volatility is considered to be an ideal tool for a short-term investor to generate high returns from his portfolio. Emerging markets’ stocks are high beta as compared to developed markets’ ones. Beta denotes the sensitivity of the mutual fund towards market movements. It is the measure of the volatility of the mutual fund portfolio to the market. When you are looking at the beta of a mutual fund, you are finding out the tendency of your investment’s return to respond to the ups and downs in the market. Here, the market usually refers to the benchmark index the fund follows.

Instead, it depends more on the investor’s needs and how he intends to use alpha vs. beta investing to accomplish his financial objectives. By design, a 2X leveraged S&P 500 ETF has a beta that is very near to 2 in comparison to the S&P 500. In a given time frame, it moves up or down twice as much than the index. If beta is -2, the investment moves by a factor of two in the opposite direction of the index. The majority of investments with negative betas are Treasury bonds or inverse ETFs.