The “Greeks”: What are
Alpha and Beta in Stock Market terms?

What do the Greek letters used by finance experts mean? Understanding the terms alpha and beta will help you to understand risk ratio when investing. The article will also consider financial risk management and how to use a risk ratio calculator to maintain a sensible level of risk in your portfolio. 

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 when investing. 

We will be looking at the Greek letters in finance that experts use, to see how they provide us with useful metrics. We will also see how to calculate alpha and beta of a stock.

Leading on from this, we can then consider financial risk management and how to use a risk ratio calculator to maintain a sensible level of risk in your portfolio. It isn’t just about the use of Greeks in finance, but asking the question ‘what is alpha and beta in stock market terms?’ is a good starting point.

What is the alpha of a stock?

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The term alpha in stocks refers to the excess return on an investment i.e. the advantage a stock/investment strategy has over the market. If you see the alpha of a stock mentioned, then you are looking at a historical measure telling you how well it has performed. 

The alpha stock meaning lets us compare the amount it has returned against some sort of benchmark, such as a market index. This lets us see how the stock measures up, and a high alpha is something you should always look for.

We can also use an alpha stock alert to see how an active portfolio manager is performing. Are they performing above the benchmark level? If so, this person will be described as high alpha. 

If we look at alpha hedging, we can see the importance of this term, as it tells us the risk of investing in a certain stock or fund.

What does seeking alpha mean in stocks? If you see this phrase used, it simply means that the investor is looking to out-perform the market. 

Ultimately, this can be called a risk ratio calculation, as alpha tells us whether an investment performs well enough to make it worthwhile putting money into it, while expecting a solid return.

The term alpha in stocks refers to the excess return on an investment i.e. the advantage a stock/investment strategy has over the market.

How to calculate alpha of a stock?

We have to begin to answer the question of how to find alpha of a stock by looking at the benchmark used. The result of this calculation will vary significantly depending upon the benchmark that we use. It is often a major index such as the S&P 500 that is used for this purpose.

The reason why a certain benchmark has been chosen is important, as this helps to confirm that the correct index has been chosen to truly reflect the performance you are analysing.

This is the first step in how to calculate alpha of a stock, but what comes next? The formula needed to calculate alpha is relatively simple.

•   You need to add the end price of the share or fund to the distribution per share.
•   You now subtract the start price.
•   Divide the total you have just reached by the start price.

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

What is a good alpha for a stock?

Neutral Alpha (=1)	Positive Alpha (>1)	Negative Alpha (<1)
The stock or fund we are looking at has performed at the same level as the benchmark.  In this case, you are looking at a company that has stayed in touch with the rest of the market but that probably hasn’t done anything noteworthy to increase its value above that of its rivals.	The stock could provide potential for a high return, based on its historical performance. This company has enjoyed more success than the market average, meaning that there appears to be something about them that is worth looking at more closely.	The stock in question may be of a higher risk level than you would like.  For some reason, this negative alpha stock has under-performed the market, which should set the alarm bells ringing and cause us to look for a reason for this poor performance.

What does beta mean in stocks?

Beta in stocks is a way of measuring the volatility of a stock compared to the market’s average volatility.

The second letter of the Greek alphabet leads us to look at volatility. What is beta in stock market terms? As with alpha, the stock beta meaning involves comparing the performance of a stock’s price to a benchmark index such as the S&P 500.

However, in this case, we concentrate on the volatility levels of the stock and the benchmark. This gives us another type of risk ratio to consider. 

The beta value of stocks is an important factor when deciding how to invest, as it tells us the risk/reward potential of a stock. In other words, the amount of potential upside there is to a stock vs. its volatility (how much its price fluctuates).

Beta in stocks is a way of measuring the volatility of a stock compared to the market’s average 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 gains 10%, this stock would gain 20%. On the other hand, if the benchmark loses 10%, this stock will also lose 20%.

Therefore, a high beta in stock market terms suggests that we are going to see a high degree of price movement. This means that it is a riskier investment but provides the possibility of higher returns. A high stock beta coefficient might be right for some investors but not for others.

When we look at the issue of what beta means in stocks, we also need to think about how to find the highest beta stocks in S&P 500 or other important indices.

Tip: These strategies can help you to find the latest beta stocks in a variety of ways.

A look at some stock beta values

We can make this subject a bit clearer by doing a beta stock analysis of some of the most popular shares in the market. These figures have been calculated over a year.

•     Apple stock beta – 1.2524
•     Adobe stock beta – 1.1831
•     Amazon stock beta –  0.8746
•     GM stock beta – 1.2272
•     Google stock data (Alphabet) – 1.0279

How do you choose the right options to increase your chances of earning profit but without making the risk level unacceptably high? Beta hedging involves choosing different stocks whose beta scores offset one another. 

In this way, you look to achieve an overall neutral beta score that matches the benchmark.

Tip: The beta value of stocks is an important factor when deciding how to invest, as it tells us the risk/reward potential of a stock.

How to calculate the beta value of a stock?

As we have seen, you can find out very quickly online which companies have high beta stocks and which are regarded as low beta stocks. But how is this figure calculated? We calculate beta of stock using the following details:

•       The covariance is the stock’s overall return compared to that of the market being used as a benchmark
•       The variance is the movement in the market compared to its mean value.

Once we have both of these figures and know how to calculate beta value of a stock, we simply divide the covariance by the variance. 

Neutral Beta (=1)	Positive Beta (>1)	Negative Beta (<1)
This stock has, theoretically, the same level of risk as investing in the overall market would.	The stock is more volatile than the index, with a higher risk ratio. .	The stock is expected to move less than the benchmark.

Of course, it is easier to check the beta score of stocks online as we saw earlier. However, you might decide that you want to work out this figure for yourself, to take into account a different period or for some other reason. 

Tip: Knowing how to calculate beta of stock gives you the knowledge needed to fully understand where the score comes from.

Now that we have seen how to check beta of a stock, we can see more easily how to use the results to make diversified investments. 

By choosing stocks or funds with different beta values, we expect them to react differently to any economic events and situations, which is one way of attempting to lower the risk level of your portfolio.            

Tip: You can also easily see beta value of any stock in the stats tab on eToro. 

This number is shown alongside other useful details that help you to fully understand the risk and reward potential of any stock.

What is CAPM? Explaining the Capital Asset Pricing Model

CAPM is the relationship between risk and return within assets such as stocks.

The Capital Asset Pricing Model, CAPM, is another worthwhile area to look at when considering how to calculate risk ratio on stock investments. 

This approach considers the link between risk and expected return. It is typically used alongside the likes of technical analysis and fundamental analysis, to help us estimate the expected earnings taking into account the risk.

The CAPM formula takes the alpha and beta scores of the stock into account, as it gives us an overall look at the risk and the cost of capital. By looking at these different areas together with the CAPM equation, it is possible to understand any investment decisions better.

Alpha tells us whether an investment performs well enough to make it worthwhile putting money into it

The advantages and disadvantages of Capital Asset Pricing Model methods is an area of discussion in the financial industry. Some people believe that it provides a useful figure for basing decisions on, while others believe that the limitations of CAPM in simplifying the financial markets render it less useful.

If you are aware of the benefits of the CAPM model, as well as the limitations of the Capital Asset Pricing Model, it is something that can be used together with alpha stock and beta stock information to make fully informed investment moves.

Advantages of CAPM	Disadvantages of CAPM
Gives an overall look at the risk and the cost of capital Easy to use Helps to understand investment decisions	Overly simplifies the financial markets Difficult to determine a beta Based on too many assumptions

Other “Greeks”: Delta, Gamma, Theta, Sigma

Alpha and beta aren’t the only Greeks finance letters you will find. Other letters are also used in the investment industry, although they are mainly seen in options trading. 

This is an area where investors look to buy and sell assets at a pre-determined price, allowing us to attempt to generate recurring income or to speculate on potential price changes.

Options are part of the investment class known as derivatives. Bearing this in mind, the other Greek letters finance experts use in this context are as follows.

Delta and delta hedging

• Delta is the rate at which an option increases or decreases in value according to each $1 change in the price of the underlying stock.
• A delta positive score suggests that there is a higher level of sensitivity or correlation with the underlying stock. 
• A negative delta score suggests a lower sensitivity. However, it is important to bear in mind that the scales vary for call and put options.
• What is delta hedging? This is a way of attempting to make the entire portfolio delta neutral by offsetting positions with different delta values on them. An example of delta hedging would be where the investor constantly changes positions to maintain a delta neutral strategy at all times.

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Gamma and gamma hedging

• Gamma is the rate of change in an option’s delta score.
• Gamma is a term used in investing to explain the rate of change in delta for every move in the underlying asset’s value. What this means is that it tells us about the exposure to price changes, both negative and positive. 
• A high value for gamma lets us see that this option is likely to undergo more volatility and larger price swings. In general terms, the majority of traders will look for stability rather than a high level of volatility.
• What is gamma hedging? This is a way of trying to keep the delta rate as zero, regardless of whether the underlying assets increase or decrease. 
• Gamma hedging strategies include adding new options that provide a contrast to the existing options. The idea of gamma neutral hedging becomes more important in the final period before the expiration of the option.

Tip: You can check out eToro’s risk score to quickly understand what to expect from an investment.

Sigma

• The next of the Greeks finance letters is Sigma, which is used to explain the concept of standard deviation. This is the probability that a particular number in a sequence varies from the mean.
• Sigma is a measurement of variability, i.e. how much variation there is in a stock’s statistical average. Sigma standard deviation in investing looks at risk, because the higher the deviation the greater the risk involved in that investment. 
• What is the difference between sigma and standard deviation? The Greek letter is used to express standard deviation, so it is really just the same thing. 

Theta

• The final of the Greek letters finance terms has been attached to is theta. Theta is the rate at which an option declines in value over time.
• This is also known as time decay, as it expresses the rate at which an option is losing value as it gets closer to the expiration date. It is usually shown as a negative figure because it represents a loss of value over time.

Greeks	Purpose
Delta	Estimates the change in price of a derivative
Gamma	Measures delta’s rate of change over time
Sigma	Measures the variability of a stock’s average
Theta	Represents a stock’s loss of value over time

Calculating risk and volatility on eToro

Getting to grips with the issues of risk and volatility using the terms we have looked at is a key part of financial risk management. The question of what is alpha and beta in stock market terms should now be clear, but isn’t it difficult to work out more details using a risk ratio calculator?

This looks at many of the same areas as the alpha and beta scores, as we look at factors such as average price shifts to work out the volatility. We then calculate an overall risk score that allows you to work out how to create a balanced portfolio that reflects your attitude to risk and volatility.

Tip: Check out eToro’s risk score to quickly understand more about an investment

Another way we help you manage risk is to set certain parameters for who you can follow with our CopyTrader feature. 

Although the tool makes it possible to follow established traders and mirror their investments, there is a default setting that makes it impossible to follow people with the highest risk scores. 

In other words, you can’t follow traders that have volatile results, even if they’re making money. Instead, you can focus on successful traders using low-risk strategies.

If you know where to find the beta of a stock and how to understand its alpha, the eToro risk score gives you the final piece of information needed to understand how it might perform in key aspects. 

Don’t just rely on the historical beta of stocks to calculate the risk ratio when additional information like this is available. Learning how to calculate alpha and beta of a stock is just part of the answer you need.

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Conclusion

With the use of Greeks, finance experts have helped us to get a clearer idea of the risk involved in different types of investment. This terminology is useful for every investor, who should understand it in terms of the risk ratio and volatility of their own investments.

• If you plan on buying an individual stock, you should consider the beta figure.

• When you work with an active portfolio manager, you need to know their alpha rating. This figure is commonly used to understand the performance of investments, such as mutual funds compared to an index fund.
• To invest in derivatives such as options, you will want to look at the other Greek letters finance terms we have covered here.

All savvy investors introduce hedging strategies to lower the risk in their portfolio. However, you need to know first of all what type of risk to reduce so that you understand the hedging strategy is the best fit.

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