What Is Beta Of Stock? Beta Stock Explained At CAPEX.com

We at CAPEX have a wide range of resources to assist our customers with stock trading. We will be focusing on indicators like beta and answering the question, what is beta of stock?

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What is beta?

Capital Asset Pricing Model (CAPM)

We should start by what is beta of stock. In the stock trading world, beta is an indicator used to measure how volatile a stock is concerning the overall stock market. It is used in the capital asset pricing model (CAPM), which is a method used to describe the relationship between the volatility (or systematic risk) and the expected return for stocks. CAPM is used frequently as a method for pricing stocks and securities that have a high risk and generate the predicted returns of those stocks and securities—at the same time, consider the cost of capital and how at risk the assets are.

Measures volatility

Beta has different values that relate to how strongly the stock’s price is affected by the market. For example, the S&P 500 Index has a beta value of 1.0. The individual stocks are then ranked and monitored depending on how much they deviate from the stock market. The more the stock swings, the value will be above 1.0, and less movement means a lower value. It is known that high beta stocks are generally at a higher risk because the volatility increases. But, there is a better chance of making more profit. A low beta stock has the opposite effect.

The idea of measuring risk can be pretty complex. But at CAPEX, we provide many tools to help our customers develop their understanding of statistical indicators and how to use them, like beta, appropriately. Beta is used mainly by analysts who want to determine how much risk an individual stock will be to their portfolio. However, the beta data will only give an idea of the risk.

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How beta works

Beta is a statistical indicator that is generally calculated using regression analysis. It is an analysis used to determine the strength and character of the relationship between a dependent variable and independent variables. On a graph, beta is represented by the slope of the line through a regression of data points. Each point shows an individual stock’s return against the overall stock market.

Beta calculation

The beta of stocks aims to describe the activity of a stock’s return as it responds to movement and swings in the market. Beta has a calculation as shown below:

Beta coefficient (β) = covariance (Re, Rm) divided by variance (Rm)

The covariance highlights how changes in a stock’s return (Re) relate to the changes in the market’s return (Rm). Whereas the variance shows how far the market’s data points spread out from their average value.

This calculation is essential in helping traders understand if a specific stock is moving in the same direction as the market or not and if it is worth investing in overall or too big a risk. In addition, the beta calculation will give an idea of the level of volatility a stock is in the overall market. Investors want to trade stocks that are at higher risk because that can increase the potential for more money to be made.

R-squared measure – Finding the right benchmark

The stocks that don’t deviate or move only slightly from the market don’t add many risks and mean there is a smaller chance for returns. To ensure the beta calculation is done correctly, you should compare the individual stock you’re monitoring is matched to the suitable benchmark. For this to be right, there should be a high R-squared value. The R-squared method is a statistical indicator that displays the percentage of a stock’s price movements and can be understood by the movements in the relevant benchmark index. Beta is used to determine the volatility or systematic risk, so a high R-squared value could mean the benchmark is relevant and best suited.

Exchange Traded Fund  (ETF)

An exchange-traded fund (ETF), like the name suggests, trades stocks on an exchange and contains a variety of investments in addition to stocks, including securities and commodities. At CAPEX, you are able to trade ETFs. An example of a prominent ETF is the SPDR S&P 500 ETF. It tracks the S&P 500 Index. In terms of the R-squared value, an example could be a gold ETF like the SPDR Gold (GLD) related to the performance of gold bullion. As a result of that relationship, the gold ETF would have a low beta value and a low R-squared value and relationship with the S&P 500 Index because that benchmark is not relevant.

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Benefits of using beta

If you want the beta stock explained, you have to consider some of the advantages of using the beta calculation. We have included a few advantages below when trading with us at CAPEX.

Variability

It is essential to consider the stock’s price variability when determining its risk. Concerning CAPM, beta does have its uses. Stock’s and other assets are known to lack consistency when it comes to price. So finding out the risk of a stock and how likely it is to continue to swing in the market is helpful for traders and investors who understand the price will not stay in one place. In addition, if you are using the CAPM, then determining the volatility will work in your favour in the long run if you know if the stock has a history of low beta values or high beta values.

Convenience

If you’re new to stock trading or have experience with the market, then using the beta method might be right for you. Once you’ve understood that the market changes can affect the stock’s price changes and vice versa, it’s a case of applying that knowledge to the statistical calculation. Here at CAPEX, we offer an online broker demo account to all our customers to allow them to practice trading with technical indicators and numerical data to know when the right time to enter and exit the market is. The more you practice this beta method, the easier it will be to have more successful trades and greater returns overall. Also, remember to visit the CAPEX Academy, our online trading school.

Accuracy

Because you are using a calculation that has a reasonably straightforward equation to follow, the results you get for the beta value are pretty accurate. At CAPEX, we want you to be able to practice different statistical analysis methods and techniques. We would recommend using beta because you can tie in what you may understand about the fundamentals of a specific stock and relate that back to the calculation.

For example, the news could be released about a company’s earnings, and it could have a positive effect on the stock market, causing investors to either buy or sell because they spot the trend that comes with this news using a trend strength indicator. They can also see if the company’s price movement is more abnormal than usual, increasing the volatility. So combining the outside influence with the beta calculation, the risk is determined, and a greater rate of return is achievable.

CAPEX has a dedicated space to help individuals learn to trade

We offer our very own curated CAPEX Academy for our customers. Our trading academy includes tailored tools such as our popular step by step online courses. These are valuable lessons to help you understand what a specific trading strategy means and why you should consider using it when executing your trades. We know our customers can master trading essentials by using our online space because it is the best place to get you on track.

Beta values

Beta value of 1.0

When a stock has a beta value of 1.0, there is a strong correlation between the price movement and the movement in the stock market. 1.0 indicates volatility or systematic risk, but it’s not able to detect any unsystematic risks. If you’re thinking about adding a stock to your portfolio with this value, it most likely won’t add any risks. Which means it probably won’t increase your portfolio’s chance for a greater return.

Beta value greater than 1.0

If your beta value is higher than 1.0, it means, by definition, the stock’s price is more volatile than the market. A beta value of 1.5 would mean the stock would be 50% more volatile than the stock market. It would mean the stock would increase the portfolio’s risk and potentially increase the return.

Beta value less than 1.0

If your beta value is less than 1.0, it means the stock’s price is generally less volatile than the market. It is considered a low beta value, and if you put this stock in your portfolio, it would make it less risky and less movement than the market average.

Negative beta value -1.0

When a stock has a negative beta value, it means that the stock moves in the opposite direction to the market benchmark. A few companies and industries find negative beta values common, but inverse ETFs and other tools are made for these values specifically.

 

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Risks of using beta of stocks

We’ve highlighted some benefits of using the beta of stocks, so we also wanted to discuss the disadvantages of this method and the risks associated with it if you choose to trade using the beta of stocks on CAPEX.

Volatility

Assets in the stock market can be highly volatile, some more than others. It can be used to an investors advantage, however. The higher the volatility of movement, the higher the beta value and risk, increasing the profit that investors could make. But, the issue with beta is that it doesn’t tell the traders what direction the movement will be in, whether upwards or downwards. It just records that there is a movement, which isn’t that much help for investors who look for specific swing directions.

Bias

If you’re thinking about buying and selling stocks over a short time, then using beta might be ideal. However, if you’re thinking about the long term, then it might not be as helpful. The beta measure on an individual stock is known to flip from time to time. It also doesn’t predict which direction the price will move in, so that is unclear.

Poor future stock predictions

The beta method doesn’t include new or future information. Many new stocks in the market, like technology or digital, don’t have enough information for a price history to create a reliable beta. So it may be a good idea to use this method for older stocks with a lot of history in their price fluctuations, so your beta value is more accurate. There are some flaws in this indicator because beta does not consider the price you pay for the stock and how that relates to the fundamentals like company earnings, leadership and new product releases. No matter how well you understand that area of analysis, there could still be things beta misses when determining the risk, so it’s something important to note.

Conclusion – Trade CFDs on stocks at CAPEX

Overall, the beta stock meaning is described as how substantial a stock’s volatility is concerning the stock market. We recommend using the beta of stocks because you’re following a relatively straightforward calculation if you choose to follow the capital asset pricing model (CAPM).

The aim of using beta is to find out how risky a stock’s price is and whether it will fluctuate more or less in the market. If there are more fluctuations, then the risk is generally higher, but so is the chance for generating returns.

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Beta Stock Meaning – FAQ

✍How do I calculate beta of stocks?
🤷What is a good beta value?
🚨Is the beta value of stocks important?