Knowing what measures to use to evaluate a stock can be extremely useful for stock traders & investors. Understandably, most of these measures may be complicated or downright impossible to understand.
The Beta value of stocks falls under this category. If you’re looking for a simple explanation of Beta value, you’ve come to the right place! Join us as we walk you through what Beta is and how to calculate it.
What is Beta in Stock Market?
Beta is a mathematical term that can help you understand how risky a stock is compared to the entire market. The Beta value of the market is always 1. If a stock has a high Beta (>1), then it is said to be very volatile.
On the other hand, a low Beta (<1) implies that a stock is relatively stable and less volatile than the market. That’s not all. The Beta value can also be an indicator of a stock’s ability to generate returns.
High Beta stocks have the potential to generate high returns while low Beta stocks will generate returns more or less in line with the market (or lower). If you’re wondering why the market has a Beta of 1, it’s simple.
Beta measures the movement of a stock or asset in relation to the market. What does the market move in relation to? Itself. There’s one more fact you should know.
To find out a stock’s Beta value, you must compare it to the right benchmark index. For example, it would not be optimal to find out a stock’s Beta by comparing it to a commodity index like MCX.
How to Calculate Beta of a Stock?
At the end of the day, Beta is a mathematical measure so there is a formula to calculate it. Following these steps can help you can obtain a stock’s Beta:
- Calculate the product of covariance* of the stock & market’s returns
- Calculate the variance** of the market’s returns (for a set time period)
- Divide #1 by #2 to obtain the stock’s Beta value
Here’s the mathematical representation calculating the Beta of a stock:
Beta (β) = Cov (Ri, Rm)Variance (Rm)
Ri = a stock’s return
Rm = overall market’s return
*Covariance: measure of ups and downs in a stock’s returns compared to the ups and downs in the market’s returns
**Variance: the spread between the market’s returns and its average
While we’re on the topic of mathematics, you’d be interested in knowing that Beta is the slope of a line that passes through a regression of data points, generally the returns of the stock versus the market.
Types Of Beta Values
Now that you know what Beta is and how it works, it’s important to understand the true meaning of a Beta value. This can be broadly divided into four categories:
- Beta less than 1.0: the stock is theoretically less volatile than the market. An investor’s portfolio may be less risky with a stock like this in it than without.
- Beta equal to 1.0: the stock theoretically has the same qualities as the market. Adding such a stock to a portfolio may not increase or decrease risk.
- Beta more than 1.0: the stock is theoretically more volatile than the market. Adding such a stock to your portfolio may increase risk significantly.
- Negative Beta: the stock has an inverse relationship with the market in theory. If the market goes up, such a stock may fall and vice versa.
What all of this means is that the Beta value can help a trader or investor understand whether they can add a stock to their portfolio, in line with their risk profile. But… is it truly useful? Read on.
Is Beta Value of a Stock Important?
The Beta value allows an investor to gauge the price movement of a stock in relation to its benchmark index. Theoretically, it can be useful to understand the risks & rewards associated with a stock.
However, the real world is far more unpredictable. Think of events like the pandemic or market crash of 2008. High Beta or low Beta, it does not matter. Such black swan events can drag every stock on an index.
Furthermore, just because a stock has a low Beta does not mean that it could be a potentially wise investment. A stock that’s relatively less volatile than the market could be trending downwards for a long time.
This simply means that adding a theoretically less volatile stock with a low Beta to your portfolio won’t really help with wealth creation. Not to forget Beta works on what has happened in the past.
As the overused yet important adage goes, “past performance is not a guarantee of future success”. Either way, Beta is known to be a useful component in online intraday trading strategies.
The Beta value of a stock indicates the risk it carries in relation to the overall market. To find the Beta value, you must compare the stock with the right index. Otherwise, it would be like comparing apples to oranges.
Calculating the Beta of a stock can lead to one of four possibilities.
|Less than 1||Stock less volatile than market|
|Equal to 1||Stock just as volatile as the market|
|More than 1||Stock more volatile than market|
|Negative||Stock holds inverse relation with market|
Theoretically, Beta is considered to be a useful indicator for short term risks. But it may not work well in practice considering that the real world and markets are full of surprises.
List of Few High Beta Stocks in Nifty 50
|Company Name||LTP * as of 9th June ’22|
|Axis Bank||₹ 661|
|Adani Ports & SEZ||₹ 736|
|Adani Power||₹ 288|
|Ashok Leyland||₹ 138|
|Bank of Baroda||₹ 105|
|Bank of India||₹ 46.4|
|CG Power||₹ 177|
|Canara Bank||₹ 207|
|Century Textiles||₹ 812|
Frequently Asked Questions
1. Is Low beta good for stocks?
A low Beta generally means that a stock is less volatile than the overall market. This means that the risk that the stock carries would be low. At the same time, the returns would mirror the risk, meaning the stock may not generate potentially high returns. Thus, whether or not a low Beta stock is good for your portfolio would depend on your risk profile or trading strategy.
2. Is high beta good for stocks?
A stock with a high Beta has the potential to generate significantly high returns. However, a high Beta stock is also likely to be more volatile than the overall market. This puts high Beta stocks in the high-risk, high reward category. Traders & investors must thus evaluate their risk profile before adding high Beta stocks to their portfolio.
3. What is a good beta for a stock?
The truth? It depends on the trading or investing strategy you choose. A low Beta generally means that a stock is likely to fall under the low risk, low return category. On the flip side, a high Beta stock falls under the high risk, high reward category. Some stock traders are known to prefer high Beta stocks while certain stock investors are inclined to choose low Beta stocks.
4. Does low beta mean low volatility?
Yes, low Beta generally implies that a stock is less volatile than the overall market. This, however, does not mean that there’s an absence of volatility.
You can also read:
- What are High Beta Stocks – Everything you Must Know
- What is Option Chain – How to Use Option Chain for Trading?
- How to Trade Effectively by Trading Directly from Charts?
- What Is Algo-Trading And How Useful Is It for Day Traders?
- Trade 2 Trade Stocks – What are T2T Stocks?
Happy Trading 📈