Alpha

What is Alpha?

The term alpha, when related to portfolio returns, is based off the expected return of a security or portfolio using a market benchmark and the portfolios' inherent price sensitivity (Beta) as a gauge for relative performance. Alpha is basically calculating the security or portfolio’s performance which exceeds the expectations that are set by the market and the securities price sensitivity to the market. For example, assume that a portfolio has a beta of 2. This would indicate that the portfolio would move 2% for every 1% that the market benchmark moves. An example of a typical market benchmark is the S&P 500, Dow Jones Industrial Average, or even an industry specific index if your portfolio is trading only certain types of stocks. Therefore, using our example, assume that the portfolio has actually moved 3% higher when it was only expected to move 2%. The excess return is known as the portfolio alpha, which would be 3% - 2%, or an alpha of 1.

Alpha is difference that cannot be measured by a portfolios correlation to the benchmark. It is the risk that is associated with the individual characteristic of the portfolio itself. For example, a very astute day trader or swing trader understands how to read the charts in order to take advantage of rare opportunities where volatility may increase in that stock relative to its average. That trader may take a couple percent out of that trade intraday or over a couple days and increase the portfolio’s alpha.  A portfolio manager's added value to a fund is his/her ability to generate alpha. 


Tim Ord
Ord Oracle

Tim Ord is a technical analyst and expert in the theories of chart analysis using price, volume, and a host of proprietary indicators as a guide...

Tradingsim.com
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