Beta: Use in the Stock Market
Beta measures the volatility (level of movement) of a stock as compared to that of the entire stock market. Hence, beta represents the market risk of the stock. It measures how a stock reacts and is likely to react when based on the performance of the entire market.
The value of beta is always analysed using its distance from 1. If the beta of a stock is 1.5 (i.e. if the beta of greater than 1) then the stock will react more wildly compared to the market and vice versa. Therefor, if the market moves up, the stock will move 0.5x more upward than the market. However, the same can happen on the downside. Stocks with beta greater than 1 have high risk and the investor must be cautious especially in a market crash scenario. Stocks with beta lower than 1 have lower risk which is good during a downfall but it restricts the profit in an upward moving market. Stocks with beta exactly 1 moves in the exact same proportion as the market does (but this is quite rare).
Beta of publicly listed companies is easily available online through your broker’s app/website or simply on Reuters or Bloomberg.
Beta is calculated on various date range – 3 year weekly beta, 4 year weekly beta, 5 year monthly beta, etc. There is no defined rule on which one can be the best. Based on your investment horizon and the relevant of historical returns in the industry, one can select the apt beta. For that it is recommended to define your investment well. For example, if you want to invest in a company for 5 years, a 4 year monthly beta or more can be used, however, it varies from industry to industry. In case of newly discovered industries, historical data may not be available and hence, you may only find a beta with short date range. As long as you can gauge the risk of the stock and have a plan to brace for a sudden impact, you are good to go with whatever beta you may find.
Be careful to extract beta from only one source for your entire portfolio for consistency. That way you will be able to better understand the riskiness of your portfolio.
To calculate the overall beta (riskiness) of your entire portfolio, first simply multiple beta of each company with the weight (percentage) it carries in the portfolio. Then add up the values to get the overall portfolio beta.
Hope this helps! Happy Investing!
Disclaimer: These articles are intended towards novice audience trying to understand the market with little to no knowledge about the same. The purpose is educational and must not be considered as a tip of any sort. Always make your financial decisions based on expert's personal advice to you. Also, do not forget to do your background research and not fall prey to any kind of fraud or manipulation.