“Alpha” is a measure of “edge”, or “how much better is any investor in outperforming the market”. A purely naive investor who picks a passive strategy of buying ETFs to track the market overall might see positive returns, but those returns will not outperform the market by definition and thus that investor has no “alpha”. An investor with “alpha” generally has to have some strategy or knowledge that means they are able to see value where others cannot.In large, highly liquid markets, having “alpha” is very difficult. After all, trying to “outsmart” legions of highly skilled bankers and traders seems like a Sisyphean task. If there’s a momentary mispricing, these sophisticated traders will quickly return the price to its “correct” value. The existence of alpha, then, is a bit of a puzzle. Economist Eugene Fama even won a Nobel Prize for his “Efficient Markets Hypothesis” which argues that market price should incorporate all relevant information about the underlying asset and attaining alpha is nigh impossible. Research does suggest that many people do overestimate their ability to achieve above-market returns in expectation. To the extent alpha does exist, it generally comes from a few sources:
Identifying an inefficiency before everyone else did. The MLB baseball draft was traditionally a market with little “alpha”, until the brain trust at the Oakland Athletics noticed that players who got lots of walks seemed to be far more valuable than their competitors noticed (inspiring the book and movie Moneyball). Eventually, others caught on to the strategy and the edge disappeared, but the strategy did power several highly successful seasons before it was replicated. Investors, by acquiring large amounts of expertise, can sometimes identify these strategies before the rest of the market
Lower liquidity markets where one may be trading against someone with non-economic motivations (e.g. if someone is buying something for reasons other than maximizing profit, then taking the other side of that trade may be profitable)