What Is Beta In Stock Market?
Beta is a measure of a stock’s volatility as it relates to the overall market. For example, if a stock moves less than the market, the stock’s beta is less than 1
Beta in finance is represented by either the word or the Greek letter β.
High-beta or high volitility stocks tend to be riskier, yet can provide higher returns. Low-beta stocks offer less risk, but with less risk come lower returns.
What is beta of a stock?
A stocks Beta is a numeric value that measures the fluctuations of a stock to changes in the overall stock market. For stocks, Beta measures the responsiveness of a stock’s price to changes in the overall stock market. The volatility of the stock and risk can be judged by calculating beta.
How do you calculate the beta of a stock?
How to Calculate Beta
Source: investopedia.com
To calculate the beta of a security, the covariance (how two stocks move together) between the return of the security and the return of the market must be a known factor, as well as the variance (how far a stock moves relative to its mean) of the market returns.
Covariance measures how two stocks move together. A positive covariance means the stocks tend to move together when their prices go up or down. A negative covariance means the stocks move opposite of each other.
Variance, on the other hand, refers to how far a stock moves relative to its mean. For example, the variance is used in measuring the volatility of an individual stock’s price over time. Covariance is used to measure the correlation in price moves of two different stocks.
Beta = Covariance/Variance
Example: Beta of AAPL=0.83×(0.32210.2342)=0.6035
For example, if a stock’s beta value is 1.3, it means in theory this stock is 30% more volatile than the market as a whole. The beta calculation is done by regression analysis which shows security’s response with that of the market.
Multiply the beta value of a stock with the expected movement of an index, the expected change in the value of the stock can be determined. as an example, if the beta is 1.3 and the market is expected to move up by 10%, then the stock should move up by 13% (1.3 x 10).
The formula to calculate beta is the covariance of the return of an asset with the return of the benchmark, divided by the variance of the return of the benchmark over a specific period.
Investing Using Beta
Beta is one of a number of tools investors use to determine whether you might want to invest in a specific stock. As we now know, a high beta stock can be a sign of a good but risky investment opportunity. On the other hand, a low beta value means less risk with less potential for high returns.
Negative beta stocks may be a good option to offset potential losses from investments that more closely track the market as a whole. In general, beta numbers can be good supporting information as you design a market portfolio.
If you want a more aggressive stock portfolio, the average beta of your stock would be over 1. If you prefer a more conservative portfolio, your average stock beta is under 1.
