Other funds concentrate on stocks in sectors that intrinsically have low betas, such as Utilities Select Sector SPDR Fund and Global X NASDAQ 100 Covered Call ETF. Beta is a measure of a stock’s volatility in relation to the market. It essentially measures the relative risk exposure of holding a particular stock or sector in relation to the market.
Beta in Portfolio Diversification
It depends on the magnitude of the variance between sample means. The way to manage beta risk is by boosting the test sample size. An acceptable level of beta risk in decision-making is about 10%. Think of comparing the beta of different stocks in the same way you might order food at a restaurant.
- But broadly speaking, the notion of beta is fairly straightforward.
- The calculation helps investors understand whether a stock moves in the same direction as the rest of the market.
- There are also a few industry groups, such as gold miners, where a negative beta is typical.
- In fact, its business may pick up when a poor economy leads consumers to seek ways to economize.
- One year later, Stock OW gained an annual return of 20% while the S&P 500 only grew by 12%.
- 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.
What Is Beta Risk?
There is a lot of hope baked into its share price, resulting in wild swings whenever it fails/exceeds expectations and a five-year beta of 2.41, as of June 2024. The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. In the case of levered beta, the beta increases as a company’s total debt level rises. Below is the beta formula, which breaks down how both covariance and variance are computed.
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. Beta measures risk in the form of volatility against a benchmark and is based on the principle that higher risk come with higher potential rewards. Analysts can beta be negative use beta when they want to determine a stock’s risk profile.
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Investors use beta to see whether the price of a security is moving in the same direction as the rest of the market. It also provides insights about how volatile—or how risky—a stock is relative to the rest of the market. If you compute the $\rho$ using 5-year time series and monthly or daily returns, then the short stress periods when the assets moved in different directions are likely to be “drowned out” by perdiods of low volatility. If you want to focus on periods of high volatility, you can give more weight to observations with large moves, instead of vanilla $\rho$. Similarly, a high beta stock that is volatile in a mostly upward direction will increase the risk of a portfolio, but it may increase gains. Investors who beta to evaluate a stock also evaluate it from other perspectives—such as fundamental or technical factors—before assuming it will add or remove risk from a portfolio.
As a low-priced retailer with a broad range of products, Walmart does a relatively steady business no matter what the prevailing economic conditions are. In fact, its business may pick up when a poor economy leads consumers to seek ways to economize. Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses.
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