ALPHA AND BETA:
STOCK BASICS EXPLAINED

Alpha measures performance, and beta measures volatility, and used independently or in conjunction, they provide a way of evaluating risk and reward. The statistical measures “alpha” and “beta” can help you to understand the characteristics of an asset.

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You don’t need to learn the Greek alphabet to invest in the stock market, but understanding the terms alpha and beta will help you to understand the risk ratio associated with every trade.

We will be looking at what alpha and beta are, how they are calculated, and the value of this knowledge in developing your investment strategy. We’ll also explore how a third metric, Capital Asset Pricing Model (CAPM), incorporates the concepts of alpha and beta into one tool.

What Is the Alpha of a Stock?

The term “alpha” in stocks measures any excess return on an investment in comparison to a benchmark, such as an index.

Alpha’s usefulness is in demonstrating whether, and to what extent, a stock has outperformed the general market. If you see the alpha of a stock mentioned, you are looking at a historical measure. This historical measure is not an indication of future performance.

How To Calculate the Alpha of a Stock?

Alpha is a metric based on comparative analysis, so the starting point is establishing which benchmark a stock should be measured against. The more appropriate the benchmark, the stronger the conclusions of your analysis.

If, for example, you are researching the alpha of pharma giant, Johnson & Johnson, you might choose to compare it with its direct peer group, as represented by the iShares S&P Global Healthcare Sector ETF. Alternatively you might want to measure its performance against other bluechip stocks from multiple sectors, by comparing Johnson & Johnson with the Dow Jones 30 Index.

The formula to calculate the alpha starts off by calculating the risk premium of the asset in question. This calculation establishes the difference between the expected rate of return on that asset and the return offered by a low-risk benchmark, such as the interest rate currently available on cash savings accounts, or the yield on a government bond.

Then, the final equation for calculating the alpha formula expresses the relationship between the rate of return on the asset in question (R), the return from comparable assets in the market (Rm), the risk-free rate alternative (Rf), and beta (β).

Here is the calculation:

Alpha = R – ((Rf + β(Rm-Rf))

• R = Actual return on a stock of fund
• Rf = the risk-free rate of return, for example from government bonds
• β = the systematic risk of a portfolio
• Rm = the benchmark return of similar assets, for example, a stock index

A worked example illustrates the mechanics of the calculation process and how to establish the alpha:

• R = 15% – Fund ABC invests in UK large-cap stocks and makes a 15% return over one year.
• Rf = 4% – During the time period, the rate of return on risk-free savings accounts was 4%.
• β = 1.2 – The price volatility of Fund ABC was 20% greater than that of the FTSE 100 Index, meaning the fund had a beta reading of 1.2.
• Rm = 12% – Over the same time period, the FTSE 100, which is made up of UK listed bluechip stocks, posted a return of 12%.

Inputting those data points into the formula calculates alpha:

Alpha = 15% – (4% + 1.2 *(12% – 4%))

Alpha = 15% – (4% + 9.6%)

Alpha of Fund ABC = 1.4%

The standard time frame used for these factors is the previous 12 months. However, you can calculate alpha scores on stock based on any time frame that you want.

What Are the Different Alpha Readings for a Stock?

There are three alpha readings that can be made: neutral, positive, and negative. Neutral, meaning it hasn’t under or overperformed the market; positive, meaning it has outperformed; negative, meaning it has underperformed.

Neutral Alpha (0)	Positive Alpha (>0)	Negative Alpha (<0)
The stock or fund has performed at the same level as the benchmark. The stock or fund that has changed in value inline with the broader market and hasn’t outperformed or underperformed.	The stock or fund has outperformed the benchmark it has been compared to. The data proves historical outperformance, not future outperformance, but the stock or fund may be worthy of further analysis.	The stock or fund has underperformed in comparison to the benchmark used. This doesn’t necessarily discount it from selection, but analysis would need to identify catalysts likely to cause a change in performance.

What Does Beta Mean in Stocks?

Beta is a way of measuring a stock’s volatility – the scale and frequency of its price moves over a certain time frame. To do this involves comparing the volatility of the stock to the volatility (price moves) of the wider market, typically a sector-specific benchmark.

Beta explores the risk/reward of a stock in a slightly different way to alpha. With beta, your analysis may be able to establish the amount of potential upside (or downside) there is to a stock in relation to its volatility.

Let’s imagine that a certain stock has a beta of 2. This would mean that it moves twice as much as the benchmark. So, if the overall market falls 10%, this stock should lose 20% of its value. On the other hand, if the benchmark rose 10%, this stock should rise by 20%.

Beta values of popular stocks

We can make this subject a little clearer by doing a beta stock analysis of some of the most popular shares in the market. These figures have been calculated over a trailing twelve-month period and presented in descending order.

Higher beta stocks may be higher profile names in investing circles, but that is based on the fact that their price moves are newsworthy rather than them necessarily being a good fit for your portfolio.

• NVIDIA (NVDA) stock beta – 2.1101
• Amazon (AMZN) stock beta – 1.4517
• Adobe Inc. (ADBE) stock beta – 1.2134
• General Motors Co. (GM) stock beta – 1.0839
• Johnson & Johnson (JNJ) – 0.1552

Source: eToro

*Data correct as of 22nd September, 2025

How To Calculate the Beta Value of a Stock

You can find beta measures of stocks online, for example, using the Financials tab on eToro. But there is also benefit in understanding the mechanics of how beta is calculated, which introduces the concepts of variance and covariance:

• Variance: Calculates how much an asset’s price has deviated from its longer-term average price over a certain period of time. An asset with high variance experiences greater and more frequent price moves than one with lower variance.
• Covariance: Illustrates the nature of the relationship between an asset’s returns and broader market returns. A positive covariance suggests the asset’s returns move in the same direction as the wider market, they go up and down together. A negative covariance suggests they move in opposite directions.

To establish beta:

1. Calculate the returns of both the stock (Rs) and the benchmark (Ri) over a defined period.
2. Calculate the variance of the benchmark returns.
3. Calculate the covariance of the stock returns with the benchmark returns.

Here is the calculation:

Beta = Covariance (Rs, Ri) / Variance (Ri)

• Rs = the return on the stock
• Ri = the return on the benchmark index

What Are the Different Beta Readings for a Stock?

There are three possible beta readings: neutral, positive, and negative. A stock with neutral beta has the same price volatility as the benchmark it is measured against. One with beta >1 has higher volatility than the benchmark, and one with negative beta is less volatile.

Neutral Beta (=1)	Positive Beta (>1)	Negative Beta (<1)
Over the designated time frame, this stock or fund showed levels of risk inline with the overall market.	The stock or fund has a higher risk ratio. Historical price moves were more volatile than those of the benchmark used.	Over the time period involved, the stock or fund price was less volatile than the benchmark.

What Is CAPM?

The Capital Asset Pricing Model (CAPM) is a statistical measure that describes the relationship between the expected return, and the risk of investing in, a security such as a stock.

CAPM’s essential purpose is to take the alpha and beta scores of a stock into account, and incorporate elements of both of those metrics to give an overall view of risk and cost of capital.

How To Calculate the CAPM of a Stock

The tools needed to calculate CAPM include the metrics which form part of the alpha and beta equations which have already been studied.

1. Identify the Risk-Free Rate. For example, the return on government bonds.
2. Calculate Beta.
3. Establish the Market Risk Premium (MRP) – this is the additional return an investor will receive (or expects to receive) for holding an asset which is higher risk than risk-free assets. MRP = Expected Rate of Return – Risk-Free Rate.

CAPM Formula: Expected Return = Risk-Free Rate + (Beta x Market Risk Premium)

An example of how to calculate CAPM could be as follows and considers hypothetical stock XYZ which is a US tech giant:

• Rf = 5% – During the time period, the rate of return on risk-free savings accounts was 5%.
• β = 1.9 – The price volatility of XYZ was 90% greater than that of the Nasdaq 100 Index, meaning the fund had a beta reading of 1.9.
• Rm = 12% – Over the same time period, the Nasdaq 100 Index which is made up of stocks broadly similar to stock XYZ posted a return of 12%.

Inputting those data points into the formula calculates CAPM:

CAPM = 5% + (1.9 * (12% – 5%))

CAPM = 15% + 17.1%

CAPM of stock XYZ = 32.1%

The example provided is for illustrative purposes only. It does not take into account current market conditions, fees, spreads, currency conversion costs, or any other transactional or other factors that may affect actual investment outcomes.

Final thoughts

Alpha and beta are popular metrics – useful for identifying potential investment opportunities, and they can be versatile tools which also play a crucial role in risk management.

Analysing your portfolio’s ratings using these metrics will help you to get a clearer understanding of the nature of any assets you have already bought and hold. Which is invaluable when carrying out portfolio rebalancing or hedging risk.

Visit the eToro Academy to develop your analysis techniques.

FAQs

What does seeking alpha mean?

Seeking alpha refers to the fact that an investor is looking to outperform the market. Alpha is a measure that tells an investor whether the returns of an investment exceed the returns that its beta would predict. It may be used together with other risk-related portfolio evaluation metrics, such as beta, and standard deviation.

Why is beta a useful indicator?

The beta value of a stock gives the risk/reward potential of a stock, i.e., how much its price is likely to fluctuate. It refers to the question: “What am I willing to invest and risk for this expectation?” where higher risk means potentially higher reward, and vice versa. Depending on an investor’s risk tolerance, the accepted volatility of an asset varies.

What is financial risk management?

Risk management means considering the risks involved with certain transactions, calculating them and taking measures to reduce them. The goal for an investor is not to reduce the risk completely, as some risk in investing is necessary to get rewarded, in accordance with the risk/reward ratio. Rather, the investor needs an investment strategy and tools to manage the risk, to be in line with their financial situation and goals.

What is beta hedging?

Beta hedging is the process of reducing the overall beta of a portfolio by rotating in and out of stock positions so that the beta value of the individual holdings offset each other. In its purest form, beta hedging would result in the aggregate beta of the overall portfolio being 1.0, even though the individual positions would have both high and low beta scores.

What is a good alpha score?

This will vary depending on your personal goals and risk tolerance. A day trader who is prepared to lose all their capital applying aggressive short-term strategies would target stocks with a higher alpha than a buy-and-hold investor preparing for their retirement, but generally speaking, a good alpha is one that is greater than zero.