CFDs are complex financial instruments and carry a high level of risk due to leverage. A significant proportion of retail investors incur losses when trading leveraged products such as CFDs. You should carefully consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your capital.
If you’re wondering what alpha is, it’s a metric that measures the extra return an investment generates above its market benchmark. When a portfolio outperforms the benchmark index, it produces positive alpha. When it underperforms, the alpha is negative. This indicator reveals whether the trader’s or manager’s decisions actually add value.
The indicator known as financial alpha measures the difference between an investment’s actual return and the return expected based on its risk level. An alpha of +2% means the portfolio outperformed its benchmark by two percentage points. An alpha of -1% indicates that it underperformed by one percentage point.
Understanding what alpha means allows you to assess whether a fund, a strategy, or your own trades generate real value. The market rises and falls due to general factors: monetary policy, economic data, and sector trends. That general movement is not attributable to the trader. Alpha isolates what is truly attributable to the trader’s own performance.
That’s why institutional investors seek out managers with consistent alpha. A fund that rises 15% when the market rises 14% generates an alpha of just 1%. But if it achieves this year after year with controlled risk, that extra percentage point adds up significantly.
Alpha stocks are those that, through active selection, provide additional returns to the portfolio relative to the index. These aren’t just any stocks that go up but rather those whose gains exceed what the market would have yielded at the same level of risk.
Many traders want to know how to calculate alpha. The most commonly used method is based on the CAPM (Capital Asset Pricing Model). The formula breaks down the return into measurable components.
Identify the portfolio’s actual return. This is the total return earned during the period analyzed—for example, 12%.
Determine the risk-free rate. The yield on short-term government bonds is used as a basis—for example, 4%.
Determine the portfolio’s beta. Beta measures how much the portfolio moves in relation to the market. A beta of 1.2 indicates 20% more volatility than the index.
Record the benchmark’s return. This is the benchmark index's return over the same period—for example, 10%.
Apply the formula. Alpha = actual return – risk-free rate – beta × (benchmark return – risk-free rate).
Using the data from the example: Alpha = 12% – 4% – 1.2 × (10% – 4%) = 12% - 4% - 7.2% = 0.8%. That portfolio generated 0.8 percentage points of alpha above the level expected for its risk.
A trader buys shares of a technology company at $50. After six months, the stock is trading at $58, representing a 16% return. During the same period, the S&P 500 index rose 10%, and the risk-free rate was 2%. The stock’s beta is 1.3.
Alpha = 16% - 2% - 1.3 × (10% - 2%) = 16% - 2% - 10.4% = 3.6%. The trader generated 3.6 points of alpha. Their active selection far exceeded what the market would have offered on a risk-adjusted basis.
Using alpha without context leads to false conclusions. These are the most common mistakes you should avoid.
Comparing alphas against different benchmarks.
Ignoring the measurement period used.
Confusing high returns with positive alpha.
Failing to consider beta in the evaluation.
Chasing past alpha without analyzing its consistency.
A 20% return seems excellent, but if the benchmark rose 25%, the alpha was -5%. The absolute number is misleading if not measured against the correct benchmark.
What alpha is used for in practice goes beyond an academic calculation. This metric has direct applications for active traders.
Measuring the actual effectiveness of your strategy.
Comparing fund managers using objective criteria.
Identifying whether you’re paying fees without receiving value in return.
Adjusting positions based on relative performance.
Filtering stocks with the potential to outperform the index.
If you want to understand what beta and alpha are together, think of beta as the risk taken on and alpha as the return earned above and beyond that risk. A good trader seeks high alpha with controlled beta.
Alpha is the extra return an investment generates relative to its market benchmark, adjusted for risk. It’s calculated using the CAPM model and allows you to assess whether a trader’s active decisions actually make a difference. A positive and consistent alpha is the clearest sign of genuine trading skill.