One year later, Stock OW gained an annual return of 20% while the S&P 500 only grew by 12%. In this case, Stock OW has a positive alpha because the investor earned more than the projected investment risk. Variance measures how far a stock fluctuates when compared to the complete turtle trader its mean. In the beta calculation, the market’s movement is often the one being measured by the variance.
Beta as a Measure of Risk
Volatility is a measure of how much and how quickly the value of an asset rises and falls. In financial markets, risk and volatility are closely related concepts. This stock has a beta of 1.5, which is 50% more volatile than the market. However, this also means it could earn 50% more than the market can return in a given period.
In either case, the market is represented by a selected index, such as the S&P 500.
Lower beta stocks with less volatility do not carry as much risk, but they generally provide less opportunity for a higher return. Stocks tend to be more volatile in the short term but produce relatively consistent returns over time. In that case, you’ll be more interested in short-term beta measurements since you have significantly shorter time horizons than a long-term investor planning for retirement. Like most investing factors, the definition of a good beta in a stock depends on each investor’s goals, risk tolerance and timeline.
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- A positive alpha indicates outperformance, while a negative alpha suggests underperformance relative to the benchmark.
- Think about how it may not always be best to chase the highest returns.
- But remember that beta is a backward-looking measure of one specific type of risk.
- Our writers and editors used an in-house natural language generation platform to assist with portions of this article, allowing them to focus on adding information that is uniquely helpful.
Beta is expressed as a number that shows the stock’s volatility around the index. A beta of one suggests that the stock moves in sync with the market. Risk is an unavoidable part of investing, but it’s also the driver How to buy crp of your returns. Investors look for ways to understand risk, mitigate it and measure it.
What does beta mean in stocks?
The alpha figure for a stock is represented as a single number, like 3 or -5. However, the number actually indicates the percentage above or below a benchmark index that the stock or fund price achieved. In this case, the stock or fund did 3% better and 5% worse, respectively, than the index. 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. If its beta were less than 1, it would be expected to be less volatile than the index — smaller increases and decreases.
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Usually, one of the stock prices used in covariance comes from a specific market index like the S&P 500. The second caveat for using beta is that it is a measure of systematic risk, which is the risk that the market faces as a whole. The market index to which a stock is being compared is affected by market-wide risks. So, beta can only take into account the effects of market-wide risks on the stock. A beta value of 1.5 implies that the stock is 50% more volatile than the broader market. That means higher than average risk and the potential for greater upside.
Beta can also be a screening tool for short-term traders since day and swing trading requires volatile assets with prices that move quickly (i.e., penny stocks). And since short-term traders can profit from big swings in either direction, you can use beta in multiple-day and swing trading strategies. High-beta stocks can outperform the market, underperform the market or even match the market return over time if the route getting there is circuitous enough.
Cash effectively has a beta of zero, because its value has no correlation with any stock market index. Cash doesn’t increase or decrease in value along with the S&P 500. Rebecca Baldridge, CFA, is an investment professional and financial writer with over 20 years’ experience in the financial services industry.
While Apple currently has a “Moderate Buy” rating among analysts, top-rated analysts believe these five stocks are better buys. Beta’s backward-facing nature also means it’s not very useful for evaluating younger publicly traded companies without long-term track records. You can atfx trading platform make almost anything sound smarter by adding Greek letters to it — and investing is no exception. Our writers and editors used an in-house natural language generation platform to assist with portions of this article, allowing them to focus on adding information that is uniquely helpful. The article was reviewed, fact-checked and edited by our editorial staff prior to publication. For example, a formerly low beta company can overextend itself by borrowing heavily to fund expansion, or it might acquire a firm in a new sector to gain a foothold.
We often hear the terms alpha and beta when talking about investments. These are two different measures that are part of the same equation derived from a linear regression. Don’t worry if that sounds complicated, we’ll explain it all in this article. The beta formula is useful because many different timeframes and benchmarks can measure an asset’s volatility.
