What Is Alpha?

Alpha is a term used in trading to indicate risk-adjusted performance. It is one of the 5 technical risk ratios (beta, standard deviation, Sharpe ratio, R-squared, alpha).

Alpha is calculated by comparing the volatility of a fund or security to the risk-adjusted performance of a benchmark index. The alpha of the fund or security is the excess return compared to that of the index.

For example, an alpha of +1.5 would mean that the fund or security has outperformed the benchmark index by 1.5%.

When investing in a fund or asset, alpha is one of the most desirable attributes. Fundamental investors ideally want a market neutral portfolio (0 beta) with a high alpha. Investors must be careful that the returns they receive are not simply a byproduct of a portfolio with a high beta in a bull market, as this will cause them great losses during a bear market.

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