In the world of finance, beta is a fundamental tool for assessing risk and making informed investment decisions. By understanding beta’s significance, calculation, and application, investors can build portfolios that align with their risk tolerance and financial objectives. Whether you are a seasoned investor or just starting, beta is a crucial concept to master as you navigate the complex landscape of financial markets.
Investors often calculate beta by comparing a stock’s price changes to the movements of a benchmark index, such as the S&P 500, throughout a 12-month period. But first let’s understand why it matters, since you can use plenty of free online tools and calculators to compute it yourself. MR stands for the market return, which is the return on the benchmark index you are using. RFR stands for the rate of return on a selected Treasury asset that bears no risk. A beta higher than one shows that a stock’s price is more volatile than the market. For example, a beta of 1.3 suggests that the stock is 30% more volatile than the market.
An alpha of zero suggests that an asset has earned a return commensurate with the risk. Alpha of greater than zero means an investment outperformed, after adjusting for volatility. A 2X leveraged S&P 500 ETF has a beta very close to two relative to the S&P 500 by design. It goes up or down twice as much as the index in a given period of time.
How Can Investors Use Alpha in Their Strategies?
Many growth stocks would have a beta over 1, probably much higher. A Treasury bill would have a beta close to zero because its prices hardly move relative to the market as a trading strategies for succeeding in cfd market whole. Beta can be a useful metric to determine how a stock’s price may move in relation to the overall market by examining its past performance. It can also be a useful indicator of risk, especially for investors who make trades frequently. It doesn’t account for how companies may undergo major changes in the future, for example. Still, it serves as one of many useful factors you can weigh when making investment decisions.
How comfortable are you with investing?
These revealx receives cloud security award top rankings in g2 stocks have higher returns than the S&P 500, according to the Fama and French Three-Factor Model. In this case, a small-cap value index might be a better benchmark than the S&P 500. To further illustrate the stock beta meaning, consider the assets in an index as cars racing down a congested highway with the benchmark as the road’s center line. Cars may drift away from the center line at various rates as they head toward their destination. Sticking toward the center line might be safer, but some cars are willing to sacrifice a little safety and move away from the line if it gets them to their destination faster. We are an independent, advertising-supported comparison service.
To see all exchange delays and terms of use please see Barchart’s disclaimer. Looking to avoid the hassle of mudslinging, volatility, and uncertainty? Mercedes Barba is a seasoned editorial leader and video producer, with an Emmy nomination to her credit. Presently, she is the senior investing editor at Bankrate, leading the team’s coverage of all things investments and retirement. Prior to this, Mercedes served as a senior editor at NextAdvisor.
One year later, Stock OW gained an annual return of 20% while the S&P 500 only grew by 12%. In this case, Stock OW has a positive alpha because the investor earned more than the projected investment risk. Once you have calculated the beta, you need to interpret the value to understand the stock’s risk. For example, fund managers might brag that their funds generated 13% returns when the S&P returned 11%.
- Many brokerage firms calculate the betas of securities they trade and then publish their calculations in a beta book.
- Since the benchmark is always 1 in the beta calculation, high beta stocks will have a value greater than 1, and low beta stocks will have a value lesser than 1.
- A beta less than 1.0 suggests the security will be less volatile than the market, while a beta greater than 1.0 indicates the security will be more volatile.
- A negative beta is when an asset moves in the opposite direction of the stock market.
Financial Calendars
For example, a formerly low beta company can overextend itself by borrowing heavily to fund expansion, or it might acquire a firm in a new sector to gain a foothold. Risk levels can change dramatically depending on business strategies. Yahoo! Finance is among the websites that publish beta numbers. For example, as of top 10 trend following trading strategies that work and how to use them Oct. 27, 2020, the beta for Microsoft (MSFT), as found on Yahoo! Finance, is 0.92. Someone on our team will connect you with a financial professional in our network holding the correct designation and expertise.
Investors keen to bag big capital gains or day traders looking to make a quick buck from fluctuating share prices would be more interested in high-beta stocks. The share prices of these companies historically have a tendency to jump around quite a bit. Racy stocks, such as tech upstarts with the potential to revolutionize how certain things are done, fall into this category. Investing in one could make you a fortune or lead to big losses. Their future is unpredictable and that leads to lots of speculation and price movements. High-beta stocks can outperform the market, underperform the market or even match the market return over time if the route getting there is circuitous enough.
SmartAsset Advisors, LLC (“SmartAsset”), a wholly owned subsidiary of Financial Insight Technology, is registered with the U.S. Understanding beta may help you make some smart decisions around how you build your investment portfolio. If you have a low risk tolerance, for example, you may want to focus more heavily on stocks with betas greater than zero, but less than or equal to 1.
High beta stocks are riskier but can offer higher returns, while low beta stocks are less risky but may yield lower returns. By including a mix of assets with varying beta values, investors can create a balanced portfolio that aligns with their risk preferences. A well-diversified portfolio can reduce overall risk and improve the chances of achieving a consistent return on investment. Remember, beta measures how volatile a stock’s price may be in relation to a market benchmark. To get the most out of a good beta calculation, that benchmark must be as related to the stock as possible. Taking a more sophisticated approach and using the CAPM, you can understand how the level of systemic risk impacts the expected return.
Higher beta stocks also tend to outperform in bull markets when the economy is in expansion mode and confidence is high, whereas lower beta stocks tend to fare better during recessions. Numerically, it represents the tendency for a security’s returns to respond to swings in the market. 11 Financial is a registered investment adviser located in Lufkin, Texas. 11 Financial may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. Beta is a measure of the expected movement of a stock relative to the market as a whole.