What is Beta in Stock Market Definition, Calculation & Uses

High beta stocks are riskier but can offer higher returns, while low beta stocks are less risky but may yield lower returns. The Capital Asset Pricing Model (CAPM) is a foundational theory in modern finance that helps investors determine the expected return on an asset, based on its risk relative to the broader market. At the core of the CAPM is the concept of Beta, which plays a crucial role in measuring an asset’s risk and calculating its expected return. Beta focuses on market risk and does not account for company-specific risks, such as management changes, product launches, or operational issues. These risks can impact a stock’s performance independently of the market.

Understanding Beta in Investing

• When the alpha is zero, it indicates the returns generated by the fund consistently track the benchmark.
• Beta measures the movement of a stock or asset in relation to the market.
• A beta value of 1.5 implies that the stock is 50% more volatile than the broader market.
• Manu Choudhary is a Senior Wealth Manager at Fincart, with over three years of experience in wealth management.
• Beta can give an investor an approximate idea of the risk a stock will add to a diversified portfolio.

In this plot, the horizontal axis represents the percent change in the overall market’s value, while the vertical axis corresponds to the percentage change in the stock price. The plotted data points reflect specific instances of market and stock performance over time, allowing for a direct comparison of the stock’s returns to those of the market. Determining beta involves calculating the line of best fit through these data points, which visually represents the stock’s responsiveness to market changes. Different asset groups might use different benchmarks to determine beta. Benchmarks vary by country and can also vary according to asset type (e.g., corporate bonds may have a different benchmark from stocks).

They deliver higher returns during bull markets but also come with the risk of limefx forex broker losing value when the market is down. Day traders like high beta stocks because they offer much higher risk-reward. Beta is also useful for gauging a stock’s volatility in relation to the overall stock market. JSI and Jiko Bank are not affiliated with Public Holdings or any of its subsidiaries.

An extreme example of negative beta would be an inverse S&P 500 exchange-traded fund, which targets a beta of -1 (or close to it) relative to the S&P 500 index (see figure 1). Beta of 1 means an asset is in perfect correlation to the benchmark. In other words, a velocity trade stock with a beta of 1, or close to it, is expected to move roughly in sync with the benchmark. So if the S&P 500 (our benchmark) goes up 5%, the CAPM would predict a 5% rise in the stock. 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. Cash effectively has a beta of zero, because its value has no correlation with any stock market index.

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. The arbitrage pricing theory (APT) has multiple factors in its model and thus requires multiple betas. In portfolio management, beta is used to construct a portfolio that matches the investor’s risk tolerance.

His strategic insights and unwavering commitment to excellence position him as a key player in the dynamic landscape of wealth management. Manu manages the financial affairs of more than 70 families, specializing in tax, estate, investment, and retirement planning. She crafts personalized strategies that cater to both immediate and future goals, prioritizing trust and relationship-building in her approach.

How to Calculate and Interpret the Cost of Debt

Founded in 1993, The Motley Fool is a financial services company dedicated to making the world smarter, happier, and richer. The well-worn definition of risk is the possibility of suffering a loss. Of course, when investors consider risk, they are thinking about the chance that the stock they buy will decrease in value. The trouble is that beta, as a proxy for risk, doesn’t distinguish between upside and downside price movements. For most investors, downside movements are a risk, while upside ones mean opportunity.

What Beta Means: How to Assess Risk of a Stock & Increase Profits

Investors must read and understand the Characteristics and Risks of Standardized Options before considering any options transaction. Index options have special features and fees that should be carefully considered, including settlement, exercise, expiration, tax, and cost characteristics. Supporting documentation for any claims stalled candlestick pattern will be furnished upon request. To learn more about options rebates, see terms of the Options Rebate Program.

Alpha vs Beta: Key Differences

• High beta stocks are riskier but can offer higher returns, while low beta stocks are less risky but may yield lower returns.
• Performance data represents past performance and is no guarantee of future results.
• Beta is a measure of the systematic risk involved with a stock or other investment.

In this example, the stock has a Beta of 2.0, indicating it is twice as volatile as the market. If the market increases by 10%, the stock would likely rise by 20%. Conversely, if the market drops by 10%, the stock could fall by 20%. A bad beta is determined by the investor who’s looking at the number. The fix for that problem is to compare a stock’s beta to that of its peers to see how volatile it is within its industry or sector.

The alpha can tell you whether it outperformed its benchmark after adjusting for risk. The higher the number, the more worth the fund manager’s decisions have added to your investment. While researching investments like stocks and mutual funds, you’ve probably come across terms like alpha and beta.

Q. How is Beta used in the Capital Asset Pricing Model (CAPM)?

JSI uses funds from your Jiko Account to purchase T-bills in increments of $100 “par value” (the T-bill’s value at maturity). The value of T-bills fluctuate and investors may receive more or less than their original investments if sold prior to maturity. T-bills are subject to price change and availability – yield is subject to change. Investments in T-bills involve a variety of risks, including credit risk, interest rate risk, and liquidity risk.

A positive covariance means the compared stocks tend to move together when their prices go up or down, i.e. a stock’s price may move with the overall market. For private companies or projects without a readily available beta, analysts might use the unlevered beta of similar public companies and then re-lever it according to the private company’s capital structure. This approach helps in estimating the expected return or cost of equity for the private entity, considering its unique financing mix. Investors and analysts often calculate unlevered beta to understand the intrinsic, operational risk of a business without the influence of its financing decisions. This is especially helpful when valuing companies that are significantly different in terms of debt structure or when assessing the risk of a business sector as a whole. When you calculate beta or find it listed for a publicly traded stock, you’re typically looking at levered beta.

The matched funds must be kept in the account for at least 5 years to avoid an early removal fee. Match rate and other terms of the Match Program are subject to change at any time. Yes, a higher beta coefficient means an investment is risky compared to the overall market causing larger up or down swings in price. However, risk and reward sometimes are  correlated, so there may be an opportunity for an upswing that could be profitable. But if you want to take a bigger risk in order to potentially make bigger profits, a high beta stock may be right for you. The three types of stock beta are historical beta, adjusted beta and fundamental beta.

However, a stock with the value lesser than one indicates that the volatility of the stock might be lesser than that of a stock above one. When you strip away the fancy terminology, a stock’s beta (β) is simply a measure of how risky that stock is. Beta analysis can be a useful tool for building a balanced portfolio, although it has limitations. Think of comparing the beta of different stocks in the same way you might order food at a restaurant. These have some similarity to bonds, in that they tend to pay consistent dividends, and their prospects are not strongly dependent on economic cycles.

When you discover the investment that’s right for you, you won’t have to wait long to invest. Public provides the Instant Transfer feature to make sure you can invest right away. The choice of method ultimately doesn’t impact the end result of obtaining the beta value. Morgan Self-Directed Investing account with qualifying new money. The beta on Yahoo! compares the activity of the stock over the last five years to that of the S&P 500 Index.