Stock prices go in the second column and benchmark prices in the third. Next, calculate the daily price changes for each (subtract current day price from previous day price, divide by the previous day price and multiply by 100). Risk is an unavoidable part of investing, but it’s also the driver of your returns. Investors look for ways to understand risk, mitigate it and measure it. Low beta generally means lower price volatiltiy than the average stock. At the same time, many technology stocks are relatively new to the market and thus have insufficient price history to establish a reliable beta.
Editorial integrity
How should investors assess risk in the stocks that they buy or sell? While the concept of risk is hard to factor in stock analysis and valuation, one of the most popular indicators is a statistical measure called beta. Alpha and beta are metrics that investors use to analyze the risk of a security or portfolio.
Adding an asset to the market portfolio
He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem. Beta’s backward-facing nature also means it’s not very useful for evaluating younger publicly traded companies without long-term track records. This may influence which products we review and write about (and where those products appear on the site), but it in no way affects our recommendations or advice, which are grounded in thousands of hours of research. Our partners cannot pay us to guarantee favorable reviews of their products or services. 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. An index that represents all of the market is a CAPM assumption, but in reality $m$ is typically some stock index (like the S&P 500, which represent U.S. large cap stocks).
Specialties include general financial planning, career development, lending, retirement, tax preparation, and credit. Andy Smith is a Certified Financial Planner (CFP®), licensed realtor and educator with over 35 years of diverse financial management experience. He is an expert on personal finance, corporate finance and real estate and has assisted thousands of clients in meeting their financial goals over his career. Alpha is excess return in relation to a benchmark and is commonly used to reveal how much active fund managers outperform the index they are trying to beat.
For example, calculating a bond ETF’s beta using the S&P 500 as the benchmark would not provide much insight because bonds and stocks are too dissimilar. Beta is the volatility of a security or portfolio against its benchmark. It’s a numerical value that signifies how much a stock price jumps around. The higher the value, the more the company tends to fluctuate in value. A beta value of 1.5 implies that the stock is 50% more volatile than the broader market. That means higher than average risk and the potential for greater upside.
- A Beta of 1.0 shows that a stock has been as volatile as the broader market.
- Others are willing to take on additional risk for the chance of increased rewards.
- This is what makes finding a non-financial/derivative negative beta stock so hard.
- At the end of the trading day, we conclude that “the markets” were up or down.
- Conversely, low-beta stocks pose less risk but also offer lower potential returns.
Is Beta a Helpful Measure for Long Term Investments?
Beta risk is sometimes called “beta error” and is often paired with “alpha risk,” also known as a Type I error. Alpha risk is an error occurring when a null hypothesis is rejected when it is actually true. It is also known as “producer risk.” The best way to decrease alpha risk is to increase the size of the sample being tested with the hope that the larger sample will be more representative of the population. Any estimates based on past performance do not a guarantee future performance, and prior to making any investment you should discuss your specific investment needs or seek advice from a qualified professional. Yahoo Finance’s beta calculations are based on monthly returns over the last five years, while FinViz doesn’t specify the data it uses to calculate beta. 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.
Negative Beta
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. 11 Financial’s website is limited to the dissemination of general information pertaining to its advisory services, together with access to additional investment-related information, publications, and links. Beta refers to the volatility of a stock in relation to the market. A benchmark index, such as the S&P 500, is chosen to represent the market in the beta calculation. Based on the beta, the particular stock could have grown to only 18%, 50% more than the market’s return.
Beta is calculated using two specific components, covariance by variance. Covariance measures how the stock moves in relation to the market, while variance measures how far a stock fluctuates compared to its mean. Investors considering active or passive investment strategies should understand the role of beta.
The investing information provided on this page is for educational purposes only. NerdWallet, Inc. does not offer advisory or brokerage services, nor does it recommend or advise can beta be negative investors to buy or sell particular stocks, securities or other investments. Furthermore, even assets that, in theory, could have negative betas (gold, for instance) seem to have positive betas when securitized (gold shares, gold ETF).