Beta and alpha stock market

Beta and alpha stock market

Posted: E-katerina Date: 26.06.2017

Alpha and beta are two common measurements of investment risk.

beta and alpha stock market

However, I must add a caveat before we jump in. Alpha and beta are part of modern portfolio theory , much of which is questioned by analysts including myself.

First we will examine Alpha and beta. Then we will look at how a value oriented investor can approach these two investment concepts and become a better investor. Beta is a historical measure of volatility. Beta measures how an asset i.

Alpha and Beta for Beginners | Investopedia

A beta of 1. A beta of -1 implies a negative correlation where the asset moves in the opposite direction but equal in volatility to the benchmark. A beta of zero implies no correlation between the assets. Any beta above zero would imply a positive correlation with volatility expressed by how much over zero the number is.

Any beta below zero would imply a negative correlation with volatility expressed by how much under zero the number is.

Beta (finance) - Wikipedia

For example a beta of 2. A beta of 0. Alpha is used to measure performance on a risk adjusted basis. The goal is to know if an investor is being compensated for the volatility risk taken. The return on investment might be better than a benchmark but still not compensate for the assumption of the volatility risk.

An alpha of zero means the investment has exactly earned a return adequate for the volatility assumed. An alpha over zero means the investment has earned a return that has more than compensated for the volatility risk taken. An alpha of less than zero means the investment has earned a return that has not compensated for the volatility risk assumed.

By risk adjusted we mean an investment return should compensate for beta volatility. According to Modern Portfolio Theory if an investment is twice as volatile as the benchmark an investor should receive twice the return for assuming the additional volatility risk.

If an investment is less volatile than the benchmark an investor could receive less return than the benchmark and still be fairly compensated for the amount of volatility risk taken.

Is this a good investment? The Alpha for this stock was -3 and tells us it was not a good investment even though the return was higher than the benchmark.

Volatility can be a blessing or a curse. That depends on how you, the investor, react to it. If you buy when everyone else is the price is high and sell in a panic when everyone else is selling the price is low then volatility is a curse.

We are all prone to emotional bias. However if you anticipate volatility it can be a blessing. The key is to stay focused on buying investments with a margin of safety. That means being disciplined in your approach to buying and selling. If you require a margin of safety it forces you to buy at a low price and sell when the price exceeds its value.

The slogan for the Dividend Value Builder is: Learning how to employ a margin of safety into your investment analysis helps you eliminate the emotional bias that causes us to make catastrophic errors. The time to buy any asset, but especially a high beta stock, is when the price is well below its real value. Your risk is lower and your probability of a positive return is exponentially higher.

Whether you are buying high beta stocks or dividend stocks; being patient and only buying investments whose price is less than the real value of the asset lowers your risk substantially. Real risk is losing your principal. I trust this discussion of alpha and beta has improved your understanding of what is takes to be a more successful investor. The most important thing you can do is develop a risk management plan. Positive alpha can be achieved with proper asset allocation, diversification, choosing individual investments with strategic advantages, and most importantly employing valuation strategies including requiring a margin of safety.

A Key to Successful Value Investing. Arbor ETF Portfolios Newsletter: AAAMP Value Newsletter - Global Deep Value Asset Allocation Portfolio. Disclaimer While Arbor Investment Planner has used reasonable efforts to obtain information from reliable sources, we make no representations or warranties as to the accuracy, reliability, or completeness of third-party information presented herein. The sole purpose of this analysis is information. Nothing presented herein is, or is intended to constitute investment advice.

Consult your financial advisor before making investment decisions.

beta and alpha stock market

Facebook Twitter Google LinkedIn RSS. How Do They Relate to Investment Risk? Difference Between Alpha and Beta Beta is a historical measure of volatility. What Does Beta Mean? What Does Alpha Mean? Interested in Quantitative Analysis? The Correct Approach for the Value Oriented Investor Volatility can be a blessing or a curse. Value Investing Portfolio Management Guides Arbor ETF Portfolios Newsletter: About Us My name is Ken Faulkenberry, founder of the Arbor Investment Planner.

My passion is to educate individual investors and enable them to self-direct their investment portfolio. My service focuses on ideas and concepts that improve the skills of investors to manage their own money.

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