BETA
Beta is a risk measure comparing the volatility of a stock's
price movement to the general market.
Overview
- Beta is derived from a formula that measures the volatility of a stock
compared to the volatility of the market in general (as measured by a market
index such as the S&P 500, DJIA, etc). Beta's companion measure for
volatility is alpha.
- The Beta for a stock may vary in up- versus down-markets.
- Monthly data is preferred.
Beta provides a good idea of a stock's inherent risk or
sensitivity to general market fluctuations.
Signals
High beta stocks react strongly to variations in the market, and
low beta stocks are less affected by market variations.
- If Beta is 1, then an issue has the same volatility as the
general market. It is either growing at the same rate or declining at the
same rate.
- If Beta is greater than 1, then an issue is more volatile. At
1.25 it will probably move 25% more than the market. If the market is in an
up trend, then the security will gain 25% more than the general market.
- If Beta is less than 1, then an issue is less volatile. At 0.5 it
probably will move only 50% or a half of the market. If the market is In a
downtrend, it will only lose 50% of what the general market loses.
- If beta is less than 0, then the stock is moving in a reverse pattern to
the index. When the index moves up the stock declines and vice versa.
Calculating Beta
To calculate
the 200-day Beta for a stock (in comparison to the S&P index), you would compute
the 200 one-day percentage changes in S&P and the 200 one-day percentage changes
in the stock. These calculations produce 200 ordered pairs that are then charted
as a scatter graph, and the slope of the least-squares-fit line is the value for
beta. (Alpha is the y-intercept of the least-squares-fit line.)