What is an alpha factor?

An alpha factor is a measurable characteristic of an asset that is associated with future returns. 'Alpha' is the return a strategy earns beyond what the market gives you for free; a factor is a systematic, repeatable source of it.

Factor versus signal

• A factor is the underlying characteristic — for example, 'cheapness' or 'recent strength'.
• A signal is the concrete, computed number you trade on — for example, a rank of every stock by its price-to-earnings ratio this morning.

A factor becomes a signal once you define exactly how to measure it, on what universe, and how often you refresh it.

Where factors come from

Two broad justifications, and both matter:

• Risk-based — the factor pays a premium because it carries a real risk that investors must be compensated for bearing (value stocks may be cheap because they are genuinely riskier).
• Behavioural — the factor pays because of persistent human biases (investors chronically overreact or underreact), creating mispricings that are slow to correct.

A factor with a credible economic reason to exist is far more likely to survive than one found by blindly mining data. A pattern with no story is probably noise.

The decay problem

Once a factor is published and widely known, more capital chases it and the premium shrinks — sometimes vanishing entirely. Alpha is competitive and perishable. The factors in the next lessons are the classic, well-documented ones; their existence is not in doubt, but their richness today is far thinner than when they were discovered.