What is Beta in Stocks & 5 Reasons Investors Use It?

Understanding beta in stocks is essential for any investor seeking to understand risk and volatility. Find out more in our in-depth guide to beta.

Beta in stocks is a financial metric that defines the volatility and the risk of a stock or portfolio. Beta is not a perfect measure, but it helps indicate how a stock will perform in a given market cycle.

If you’re a stock investor, you’ve likely heard the term “beta.” But what is beta, exactly? And why is it important, and how can you use it to measure and manage risk?

Here are all the facts about beta and the five things you need to know.

What is beta in stocks?

Beta measures the volatility of a stock and, therefore, its risk compared to a broad market index like the S&P 500. The S&P 500 has a beta of 1, so if a stock has a beta of 1.2, that stock will generally be 20% more volatile than the market.

What is Beta in Stocks & 5 Reasons Investors Use It?
What is Beta in Stocks & 5 Reasons Investors Use It?

What does a stock’s beta mean?

If the overall market increases by 1%, a stock with a Beta of 0.8 will be expected to increase by 0.8%. If the market decreases by 1%, a stock with a beta of 0.5% will be expected to decrease by only 0.5%.

Beta, in effect, measures the expected stock price movement compared to the broader market. If you seek to minimize downside risks, you might seek a low beta stock; if you are looking for stocks to outperform the market, you will seek high beta stocks.

Key Takeaways

  • Beta measures the volatility of a stock versus the broader market
  • Stocks with a beta of 1 move in line with the market,
  • Low beta stocks <1 are less volatile, and High beta stocks>1 are more volatile than the market
  • Portfolio managers measure the beta of entire portfolios
  • There are also negative beta ETFs

The formula for the beta of a stock is:

Beta = covariance of stock’s returns and market’s returns /variance of market’s returns

What is beta’s covariance?

Covariance is a measure of how much two stocks move together. It’s calculated by taking the product of the stock’s returns and the market’s returns and then dividing by the number of periods.

What is beta’s variance?

Variance measures how much a stock’s return varies from period to period. It’s calculated by taking the square of the stock’s returns and then dividing by the number of periods.

5 things to know about beta

1. Beta is a measure of volatility.

Beta measures how much a stock’s price moves in relation to the overall market. A stock with a beta of 1.5 is considered more volatile than the market average, while a stock with a beta of 0.5 is considered less volatile.

2. Beta can be used to manage risk.

By understanding a stock’s beta, investors can make more informed decisions about how much risk they’re comfortable taking on. For example, an investor who wants to minimize risk might only invest in stocks with betas below 1.

3. Some stocks don’t have a beta calculation.

For stocks that don’t trade frequently or that don’t have enough data available, it’s not possible to calculate beta. In these cases, analysts will often use the beta of a similar stock as a stand-in.

4. Betas can change over time.

A stock’s beta isn’t static; it can change as the underlying company’s business, and the overall market conditions change. That’s why investors need to keep track of a stock’s beta over time and not just rely on its historical beta when making investment decisions.

5. How to find a stock’s beta.

Most major financial publications (like The Wall Street Journal or Barron’s) list betas for stocks in their regular market reporting. But you can easily use a free stock screener like Finviz to find stocks with a high, low, or negative beta.

Keep reading to find out how to screen for beta in stocks.

Examples of using beta in stock investing

An investor who wants to minimize risk might only invest in stocks with betas below 1. For example, investors might choose to invest only in stocks with a beta of 0.5 or less. This would limit the volatility the investor experiences and reduce their overall risk.

However, it’s important to note that a stock’s beta isn’t static; it can change over time. So if an investor only invests in stocks with low betas, they need to make sure they’re still monitoring those stocks’ betas regularly to ensure they remain low.

What is considered a high Beta for Stocks?

A high beta for stocks would be anything over 1.0. A stock with a beta of 1.5 is considered 50% more volatile than the market average, while a stock with a beta of 2.0 is twice as volatile. So a high beta for stocks would be anything above 1.0.

Why do some stocks have a high beta?

Some stocks have a high beta because they are more volatile than the market average. For example, a stock with a beta of 2.0 is twice as volatile as the market average. This means its price is more likely to move up or down twice as fast as the average stock.

There are several reasons why a stock might be more volatile than the market average. It could be because the company is doing well, but investors are expecting it to do even better (so they’re buying shares in anticipation of future growth), or it could be because the company is doing poorly and investors are selling off their shares in anticipation of a future decline.

Whatever the reason, investors need to be aware of a stock’s beta before they buy shares in order to understand the amount of risk they’re taking on.

5 steps to find high beta stocks

To easily find a list of high beta stocks, follow this process:

  1. Visit Finviz, a free stock screener
  2. Click screener
  3. Choose the technical tab
  4. Select “Over 1” in the beta box
  5. Select the technical in the column area
5 Steps: How to find high beta stocks?
5 Steps: How to find high beta stocks?

What are low Beta stocks?

Low beta stocks are stocks that have lower-than-average volatility or risk. This means that their prices are less likely to move up and down than the overall market.

There are several reasons why a stock might be less volatile than the market average. It could be because the company is doing well and investors are confident in its future, or it could be because it is doing poorly, but investors think it has a good chance of recovering.

Whatever the reason, low beta stocks can be a safe investment for investors who want to minimize their risk.

What is considered a low Beta for Stocks?

A low beta for stocks is typically considered to be a beta of less than 1.0. This means that the stock is less volatile than the market average and is, therefore, a safer investment.

5 steps to find low beta stocks

To easily find a list of low beta stocks, follow this process:

  1. Visit Finviz, a free stock screener
  2. Click screener
  3. Choose the technical tab
  4. Select “Under 1” in the beta box
  5. Select the technical in the column area
5 Steps: How to find low beta stocks
5 Steps: How to find low beta stocks

What is a negative Beta in stocks?

A stock with a negative beta tends to move in the opposite direction of the overall market index. If the market increases by 1%, stock with a -1 beta would be expected to fall by 1%.

An example of negative beta in stocks

A negative beta indicates that a security is expected to move in the opposite direction to the market. For example, if the market return is 10% and a security has a beta of -0.5, then the security is expected to have a return of -5%. If that same security with a negative Beta of -0.5 is owned during a 20% stock market decline, one might expect the stock to increase by 10%.

Negative beta stocks and market declines

A stock with a negative beta is often seen as a safe investment during times of market turmoil. For example, during the financial crisis of 2008, many investors sought out stocks with negative betas as a way to protect their portfolios from losses.

Some examples of stocks with negative betas include utilities, consumer staples, and healthcare companies. These stocks tend to be less volatile than the overall market and offer investors a measure of protection when the market is going down.

Why are negative Beta Stocks so rare?

Currently, only 0.2% (less than 100) of stocks in the US have a negative beta. There are a few reasons why negative beta stocks are rare.

First, finding companies with a consistently negative beta can be difficult. Many companies are cyclical stocks and tend to move with the market.

Second, investors tend to shy away from negative beta stocks because they believe that these stocks will not offer them any upside potential during bull markets.

As a result, these stocks tend to trade at a discount compared to other stocks in the market. Finally, many investors believe that negative beta stocks are riskier than other stocks and are not suitable for all types of portfolios.

5 steps to find negative beta stocks

To easily find a list of negative beta stocks, follow this process:

  1. Visit Finviz, a free stock screener
  2. Click screener
  3. Choose the technical tab
  4. Select “Under 0” in the beta box
  5. Select the technical in the column area
How to find a list of negative beta stocks using Finviz
5 Steps: How to find a list of negative beta stocks using Finviz

What are Negative Beta ETFs?

Negative beta ETFs are exchange-traded funds that invest in stocks with a negative beta. This means that the ETF is expected to move in the opposite direction of the market. As a result, negative beta ETFs can be used to hedge against losses during times of market turmoil.

Many investors use negative beta ETFs as a way to protect their portfolios from large swings in the market. By investing in stocks that are expected to move in the opposite direction of the market, investors can help minimize their losses during times of volatility.

Negative Beta ETFs

There are a few negative beta ETFs available on the market, including the ProShares Short S&P 500 ETF and the Direxion Daily Financial Bear 3X Shares. These ETFs use hedging, options, and negative beta stocks to ensure the fund moves in the opposite direction to the benchmark index. For example, the Direxion Daily Financial Bear 3X Shares will have a  Beta of -3, as it is designed to move at 3 times in the opposite direction of the market. As a result, they can be used as a tool for hedging against losses.

Finding the beta of a stock portfolio

The easiest way to calculate the beta for an entire portfolio is to use a stock screener like Stock Rover. Stock Rover is a free and premium tool that enables powerful stock research, portfolio analysis, and management.

5 steps to find the beta of a portfolio

  1. Sign up for Stock Rover for Free
  2. Click Portfolio Tools / Analysis
  3. Select Risk & Reward
  4. View the beta for your portfolio
  5. Compare your portfolio performance against the S&P 500
Using Stock Rover to Analyze Portfolios for Beta
Using Stock Rover to Analyze Portfolios for Beta

How to calculate a stocks beta

Stock beta is a number that tells you how much the stock moves compared to the market. A beta of 1 means that the stock moves as much as the market, while a beta of 0 means that the stock moves less than the market. A beta over 1 means that the stock moves more than the market.

Some stocks have a negative beta which means they move in the opposite direction of the market. For example, if the market goes down 1%, a stock with a beta of -1 would go up 1%.

You can calculate a stock’s beta by regressing the stock’s return against the market’s return. Beta is the slope of this line.

To calculate beta, you need two things:

  • The historical price data for both the stock and the market
  • The historical return data for both the stock and the market

You can get this data from a financial website like TradingView. Once you have this data, you can use a spreadsheet program like Excel to calculate beta.

Here’s how to calculate beta in Excel

  1. Enter the stock’s price data into one column and the market’s price data into another.
  2. Calculate the return for each period by subtracting the previous period’s closing price from the current period’s closing price and dividing it by the previous period’s closing price.
  3. Enter these return figures into two more columns, one for the stock and one for the market.
  4. Highlight the four columns of data.
  5. Click on the “Data” tab and select “Data Analysis.”
  6. Choose “Regression” from the list of options.
  7. Select the stock’s return column as the “Y Variable” and the market’s return column as the “X Variable.”
  8. Click on the “Output Options” button and choose to output the regression table.
  9. Click on the “OK” button.

The beta will be listed in the regression output table. A beta of 1 means that the stock moves as much as the market, while a beta of 0 means that the stock moves less than the market. A beta over 1 means that the stock moves more than the market.

Some stocks have a negative beta which means they move in the opposite direction of the market. For example, if the market goes down 1%, a stock with a beta of -1 would go up 1%.

What are the disadvantages of beta in stocks?

The main disadvantage of using beta as a measure of risk is that it doesn’t consider individual stock characteristics. For example, a high-beta stock might be riskier than a low-beta stock, but it could also offer higher returns. Therefore, using beta as the only measure of risk can lead to inaccurate conclusions.

Another disadvantage of beta is that it only looks at historical data, which may not represent future movements. For example, a stock could have a high beta during a bull market but a low beta during a bear market. This would create the false impression that the stock is riskier than it actually is.

The last disadvantage of beta is that it’s calculated using past data, which may not indicate future movements. Beta is based on the assumption that past behavior will continue into the future, but this isn’t always the case. For example, a company could restructure its business and reduce its risk, but this wouldn’t be reflected in its beta in the near term.

Conclusion

In conclusion, while beta can be a useful measure of risk, it has several disadvantages that should be considered before making investment decisions.

So there, you have five things to know about beta and why it matters to investors. By understanding beta, you can make more informed decisions about which stocks to buy (and sell) and how to manage your overall portfolio risk.

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