One of the most commonly used metrics to analyze the risk of shares is the beta, or beta coefficient ().. It is a measure of a stock’s volatility relative to the market or benchmark index.stock with high volatility
To understand it, the market or benchmark has a beta of 1, and individual stocks are ranked according to how much they deviate from the market.
If a stock that fluctuates more than the market over time has a beta above 1, Conversely, if a stock moves less than the market, its beta is less than 1.
As an example, a value with a beta of 1.63 will mean that it is 63% more volatile than the market. Likewise, a security with a beta of 0.8 would be 20% less volatile than the market. Let’s imagine that the market is expected to rise 10%, and we identify a security with a beta of 1.3. Because those stocks are 30% more volatile, you’d expect a 13% upside.
Then there are isolated cases such as Beta 0, which means that the stock does not move and would be “risk-free,” and when it is less than 0 it indicates an inverse relationship to the market: it goes up if the market goes down and vice versa.
High-beta stocks are riskier but offer higher return potential, and low-beta stocks are less risky but also have low return potential.
Your calculation
The calculation of the beta is formed from the numerator, which is the covariance of the asset in question, while the denominator is the variance of the market. These complicated-sounding variables are simple in their computation. stock with high volatility
Here is an example of the data you will need to calculate beta:
- Risk-free rate (typically Treasuries with at least two years).
- Return on the security in question (usually one to five years).
- The performance of its benchmark index over the same period as the security
To show how to use these variables to calculate beta, we’ll assume a risk-free rate of 2%, our stock’s rate of return is 16%, and the benchmark’s rate of return is 9%.
Start by subtracting the risk-free rate of return from both the security in question and the benchmark index. In this case, the rate of return on our assets net of the risk-free rate would be 14% (16% minus 2%). The same calculation for the benchmark index would yield 7% (9% minus 2%).
These two numbers, 14% and 7%, respectively, are the numerator and denominator of the beta formula. Fourteen divided by seven yields a value of 2, and that’s the beta of this hypothetical value. On average, we would expect an asset with this beta value to be 200% as volatile as the benchmark.
Taking advantage of the beta to design our portfolio
Understanding the beta, we can now take advantage of it to structure our investment portfolio.
A good portfolio would include high beta stocks when markets are bullish and more low beta stocks when markets are bearish because high beta stocks rise more than the benchmark when markets are bullish and fall more than the market index when markets are bearish.
We can also assess it based on the investor’s profile and the time horizon of the portfolio. Young or low-risk investors with a lengthy portfolio horizon will seek bigger returns with stocks with high betas.
Very conservative profiles or those who want to preserve their assets because the time horizon of their portfolio is very short will tend to decline in risk, and the shares in the portfolio will have a low beta.stock with high volatility
