Everyone wants maximum returns with least amount of risks. This is how success of the investment is measured. For this reason, risks and returns are two key factors that stock market traders keep in mind. These are also used to gauge the chances of success. Here are two such ratios, part of technical analysis, which forecasts using previous trends and patterns:
Alpha is a measure of the success of your investment. It calculates how much a stock or fund has outperformed the general market. This follows the principle that when the market rises over time, it adds value to most of the stocks. This is called market return, and is often adjusted with risk. However, there are many stocks which outperform, usually because of higher earnings. Their return is higher than the market. Alpha calculates this difference, by comparing your stock or fund with a benchmark index. It, thus, represents how much value has added or subtracted to total returns.
A stock or fund is thus given a positive or negative alpha value, denoted as a single or double digit value. A positive value denotes outperformance, while the negative alpha means underperformance. A positive alpha of 3.5 means the stock has beat the index by 3.5%. Every investor is thus ‘seeking positive alpha’. Reading the alpha of a stock is important as it indicates the possibility of its success in the future too.
While alpha deals with the rewards of the investment, beta gives perspective about the volatility or risks involved. Just like alpha, beta too established by comparing with a benchmark index. It measures the volatility in a stock’s price and is denoted in positive or negative figures. 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.
Thus, high beta values means more risk. However, a smart investor can also use this to make gains.
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