Using Beta to measure stock volatility

Author: Steven posted in Stock selection tagged with Investing 101, Stock volatility

Measuring stock volatility with Beta

One parameter that you can use to compare the relative level of risk of a given stock to another stock is the Beta. Beta measures the volatility of a stock’s price compared to a benchmark (the market) and is commonly referred to as the Greek letter ‘ß’ by analysts. Let’s take a look at the different beta ranges and what they mean:

Beta = 1

If a stock has a beta of 1 it means that its price tends to follow the market’s movements. For example, if the S&P 500 gains 1.5% on a given day, so will the stock having a beta of 1.

Beta > 1

If a stock has a beta greater than 1 it means that its prices tends to fluctuate more than the market. The greater the beta, thus the more volatile and thus risky the stock. Aggressive growth stocks fall within this category.

0 < Beta < 1

If you are buying a stock with a beta less than 1 but above 0, then you probably are more risk averse as such stocks are usually less volatile than the market. Utility stocks fall within this beta range.

Beta = 0

Cash has a beta of 0. Thus not matter what direction the stock market takes nor by how much it fluctuates, the value of cash remains the same (assuming inflation is equal to 0).

Risk tolerance and Beta

Depending on your level of risk tolerance, your portfolio can contain stocks with different Beta values. If you are comfortable with a higher level of risk then it is not uncommon to choose stocks with a Beta of 2.5 or more. If you want to earn more than the market but limit the amount of risk, then perhaps you could select a stock having a beta of around 1.5. It would still earn you 50% more than the market. Before buying stocks based on their Beta, make sure you have your investment strategy and asset allocation well-defined. High Beta stocks can bring high returns during a bull market but at the same time then can have a big impact (yes, negative) during a downturn.

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