CandleFocus Glossary Editor
Beta is an important concept for investors to understand when making decisions about where to invest their money. It reflects the volatility or systematic risk of a security or portfolio compared to the market as a whole. To explain what beta is, we must first define volatility or risk. Volatility is the movement from day to day or month to month of a security’s price. As a result, it is a measure of how risky a security is - high volatility indicates more risk, while low volatility indicates lower risk.
Now, let’s look at beta. Beta measures the volatility of a security’s returns relative to the market as a whole. Beta is calculated with the fundamental assumption that when the market goes up, individual stocks usually go up; when the market goes down, individual stocks usually go down. In other words, beta is a measure of a stock’s correlation to the index it is compared against. A stock’s beta should be less than 1 if it is less volatile than the market average, and greater than 1 if it is more volatile than the market average.
For example: suppose the S&P 500 goes up 5% in a particular month. A stock with a beta of 2 will go up approximately 10%. Conversely, a stock with a beta of .5 will go up 2.5%.
Beta is a useful but limited tool when investing. Beta gives you an insight into how a stock’s return may move in relation to the overall market, but it cannot predict how a stock will actually perform when the market changes. It is also important to keep in mind that beta does not take into account the unique characteristics of an individual stock like financial strength, liquidity, and management team strength. The way a stock performs compared to its peers is also not taken into account.
Overall, beta is a measure of the volatility of a security relative to the market as a whole. It is an important concept to consider when making investment decisions, but it should not be the sole basis for investing. Investors should consider other factors as well when making decisions about where to invest their money.
Now, let’s look at beta. Beta measures the volatility of a security’s returns relative to the market as a whole. Beta is calculated with the fundamental assumption that when the market goes up, individual stocks usually go up; when the market goes down, individual stocks usually go down. In other words, beta is a measure of a stock’s correlation to the index it is compared against. A stock’s beta should be less than 1 if it is less volatile than the market average, and greater than 1 if it is more volatile than the market average.
For example: suppose the S&P 500 goes up 5% in a particular month. A stock with a beta of 2 will go up approximately 10%. Conversely, a stock with a beta of .5 will go up 2.5%.
Beta is a useful but limited tool when investing. Beta gives you an insight into how a stock’s return may move in relation to the overall market, but it cannot predict how a stock will actually perform when the market changes. It is also important to keep in mind that beta does not take into account the unique characteristics of an individual stock like financial strength, liquidity, and management team strength. The way a stock performs compared to its peers is also not taken into account.
Overall, beta is a measure of the volatility of a security relative to the market as a whole. It is an important concept to consider when making investment decisions, but it should not be the sole basis for investing. Investors should consider other factors as well when making decisions about where to invest their money.