During economic cycles, some sectors perform better than others. Investors can use beta to determine which sectors to overweight or underweight in their portfolios, depending on their outlook for the broader market. First, the index used as a proxy for the markets should be diversified. Also, we need to look at the time period since a beta would vary based on the periods selected.
Some of these risks are at the forefront in the current markets. For example, geopolitical risk has received a lot of attention after China cracked down on its tech giants. Assume that the beta of an investor’s portfolio is 2.0 in relation to a broad market index, such as the S&P 500. If the market increases by 2%, then the portfolio will generally increase by 4%.
What is a good beta for a stock?
Adding a stock with a beta of 1.0 to a portfolio will not increase its overall risk, but it also does not increase the chances that it will outperform the market. Variance measures how far a stock fluctuates when compared to its mean. In the beta calculation, the market’s movement is often the one being measured by the variance.
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Others are willing to take on additional risk for the chance of increased rewards. Every investor needs to have a good understanding of their own risk tolerance, and a knowledge of which investments match their risk preferences. A low-beta stock is in a company or industry that is perceived as less sensitive to the factors that affect stock prices in general or is even likely to move in the opposite direction.
Conversely, if you feel that your portfolio is too risky — that you can’t stomach its big upward and downward swings — then there’s a good chance that your portfolio has a beta greater than 1. Adding stocks with betas of less than 1 would help decrease volatility relative to the market. Many financial data websites, such as Yahoo Finance and FinViz, will display a stock’s beta along with other metrics, including PE ratio and year-to-date performance if you search the stock’s ticker symbol. 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. We believe everyone should be able to make financial decisions with confidence.
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- Beta is a useful number to look at when you want to see whether a stock is likely to move up or down with the market or move in the opposite direction of the market.
- Instead, it’s a look at its level of volatility, and it’s important to note that volatility can be good and bad.
- Beta is the volatility of a security or portfolio against its benchmark.
- In the case of levered beta, the beta increases as a company’s total debt level rises.
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I.E. some guy can beta be negative who goes out and spends a christmas bonus on gold/guns. This is what makes finding a non-financial/derivative negative beta stock so hard. Estimators of market-beta have to wrestle with two important problems.
The value of any stock index, such as the Standard & Poor’s 500 Index, moves up and down constantly. At the end of the trading day, we conclude that “the markets” were up or down. An investor considering buying a particular stock may want to know whether that stock moves up and down just as sharply as stocks in general. It may be inclined to hold its value on a bad day or get stuck in a rut when most stocks are rising. Anything that can affect the market as a whole, good or bad, is likely to affect a high-beta stock. A Federal Reserve decision on interest rates, a tick up or down in the unemployment rate, or a sudden change in the price of oil, all can move the stock market as a whole.
Whereas Beta relies on a linear model, an out of the money option will have a distinctly non-linear payoff. In these cases, then, the change in price of an option relative to the change in the price of its underlying asset is not constant. (True also – but here, far less pronounced – for volatility, time to expiration, and other factors.) Thus “beta” here, calculated traditionally, would vary constantly as the price of the underlying changed. Let’s say the beta value of the entire stock market, as measured by an index, is 1.