For example, it would not be optimal to find out a stock’s Beta by comparing it to a commodity index like MCX or any type of currency pair. Amanda Bellucco-Chatham is an editor, writer, and fact-checker with years of experience researching personal finance topics. okcoin review Specialties include general financial planning, career development, lending, retirement, tax preparation, and credit. This website is using a security service to protect itself from online attacks. The action you just performed triggered the security solution.
- Granted, for traders looking to buy and sell stocks within short time periods, beta is a fairly good risk metric.
- Beta is expressed as a number that shows the stock’s volatility around the index.
- Yarilet Perez is an experienced multimedia journalist and fact-checker with a Master of Science in Journalism.
- However, these assets require close monitoring to avoid considerable losses if the market declines.
The covariance of the return of an asset with the return of the benchmark is divided by the variance of the return of the benchmark over a certain period. Beta is used as a proxy for a stock’s riskiness or volatility relative to the broader market. A good beta will, therefore, rely on your risk tolerance and goals.
Examples are hypothetical, and we encourage you to seek personalized advice from qualified professionals regarding specific investment issues. Our estimates are based on past market performance, and past performance is not a guarantee of future performance. What is stock beta used for in terms of portfolio analysis? It’s tempting to just look at the number on your brokerage’s app or website and assume you know how volatile that particular stock or asset is. But those assumptions require verification because beta isn’t universal. High β – A company with a β that’s greater than 1 is more volatile than the market.
This suggests that it acts independently of the overall stock market. Beta analysis can be a useful way to manage the level of risk in your portfolio, but like any financial technique, it’s not perfect. Or, even easier, you could just look up a stock’s beta online. You don’t cmc markets review need to do college-level statistical calculations by hand to find a stock’s beta (unless you want to, for some reason). We believe everyone should be able to make financial decisions with confidence. For example, the β of most technology companies tends to be higher than 1.
What does a stock beta of 0.5 mean?
However, their reference or benchmark is not an index but interest rates. Bonds, ETFs, and cash are other assets you can purchase for your investment. Beta can also help identify potential high-performing stocks for your portfolio. You can spend more on high-beta stocks during bullish seasons.
Beta in Theory vs. Beta in Practice
Investors buy the stock based on it living up to its potential, which requires lots of uncertain factors going its way. A slip-up could result in the share price tumbling dramatically. Likewise, a small hint of good news can lead to another big rally. A classic example of a low beta stock would be a company like Proctor & Gamble. The maker of household brands such as Pampers, Oral, Pantene, and Gillette, as of July 2023, has a five-year beta of 0.4. In other words, its share price fluctuates much less than the broader market.
A β of less than 1 indicates that the security is less volatile than the market as a whole. Similarly, a β of more than 1 indicates that the security is more volatile than the market as a whole. Companies in certain industries tend to achieve a higher β than companies in other industries. Low β – A company with a β that’s lower than bittrex review 1 is less volatile than the whole market. As an example, consider an electric utility company with a β of 0.45, which would have returned only 45% of what the market returned in a given period. Investment professionals use this expected return, in conjunction with other valuation methods, as a basis for investment decisions.
Understanding what a stock’s beta reveals about its historical price movements
So it’s important to at least calculate the beta of a stock you may be interested in purchasing. However, beta may be a strong factor in quantifying risk if you’re the kind of investor who buys and sells stocks on a regular basis. For the rest of us, it’s much easier to calculate beta in spreadsheet programs such as Microsoft Excel or Google Sheets, which have built-in variance and covariance formulas. If its beta were less than 1, it would be expected to be less volatile than the index — smaller increases and decreases. So a stock with a beta of 0.7 would rise by 0.7% on a day that the S&P 500 rose 1%, and would fall by 0.7% on a day that the S&P 500 fell 1%.
This is not an offer to buy or sell any security or interest. All investing involves risk, including loss of principal. Working with an adviser may come with potential downsides such as payment of fees (which will reduce returns). There are no guarantees that working with an adviser will yield positive returns. The existence of a fiduciary duty does not prevent the rise of potential conflicts of interest. So if you’re examining the stock of a a large U.S. company, a good choice would be the S&P 500.
In this case, covariance will show you how changes in stock returns relate to changes in market returns. Beta measures a stock’s volatility, the degree to which its price fluctuates in relation to the overall stock market. In other words, it gives a sense of the stock’s risk compared to that of the greater market’s. Beta is used also to compare a stock’s market risk to that of other stocks.
What Is the Beta?
Besides, beta offers a clear, quantifiable measure that is easy to work with. Sure, there are variations on beta depending on things such as the market index used and the time period measured. But broadly speaking, the notion of beta is fairly straightforward. It’s a convenient measure that can be used to calculate the costs of equity used in a valuation method.
Consider looking at a stock’s fundamentals along with its beta when deciding whether to add it to your portfolio. One major drawback of beta is that it’s a backward-looking metric. It’s calculated based on past returns, which may not be consistent with future returns.