Measures of Risk

Alpha

1

Alpha refers to the ability of an investment strategy to beat the overall market. An alpha return is one that delivers an excessive return that is more than the return of the market as a whole (i.e. S&P 500).

2

Alpha can either be positive or negative. If an investment has a negative alpha, this suggests that the investor should invest in the market as a whole instead, as there is no advantage to be gained.

3

A simple way to calculate alpha is by subtracting the return of a market index from the return of a particular investment. It is best to use this calculation to compare investments from the same sector.

4

For instance, if a stock returns 15% a year and the market returns 10%, the stock would have a positive alpha of 5% (15% -10% = 5%).  If the stock returns 8% instead, it would have negative 2% alpha.

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