Explained: Difference between Alpha and Beta in stock market

Alpha and Beta are two of the widely used measures of risk that investors use for assessing investment options. But what do they mean exactly? Let’s find out!  

Alpha 

Alpha is an assessment tool that helps to calculate excess return on an investment after adjusting for market-related volatility and random fluctuations. It measures the performance/ returns of the stock or investment against its benchmark/ market index.  

Represented by the symbol ‘α’, alpha is calculated as- 

Alpha (α)= Actual Rate of Return – Expected Rate of Return 

Where, Expected Rate of Return= Risk-Free Rate + beta * Market Risk Premium  

The higher the alpha, the better. Let’s understand why- 

For example, if Stock A has an alpha of 4 and stock B has an alpha of –4, it means that stock A has outperformed its benchmark index by 4 per cent and stock B has underperformed the index by 4 per cent. 

Beta 

Also known as a beta coefficient, beta is an indicator of systematic risk, that is, the risk that can’t be avoided. It measures the volatility of stock, fund or portfolio with respect to the market. It estimates the correlation between an asset's movement and changes in the market with the help of historical data.   

For example, if a stock has a beta of 1.1, it means that it is 10 per cent more volatile than the market. 

Represented by the symbol ‘β’, beta is calculated as- 

Beta (β)= Covariance (Re, Rm)/ Variance (Rm) 

Where Re= Return on an individual stock, 

And Rm= Return on the overall market. 

Beta helps to determine how risky an investment is. A beta of 1 indicates that the stock’s price is moving in alignment with the market. A beta exceeding 1 indicates that the stock is more volatile than the market, while a beta less than 1 indicates that the stock is less volatile than the market.  

High beta stocks are preferred by investors with high-risk appetites while low beta stocks are more suited to risk-averse investors who seek steady returns.