How to Calculate Beta and what it means.
Within the financial markets, people are always looking for a new way to analyse or predict exactly what will happen to any given stock at any given time. Amongst these new methods of analysis, like technical analysis, is the notion of the “Beta” or β, which is a numerical value which describes how a particular stock might behave in the future. For an introduction on technical analysis, learning technical analysis and this course on analysis basics can really help you to understand the numbers involved.
So, Beta is a number describing a little about any given stock. The value of Beta can be
Generally, beta is used to measure risk and to inform traders and investors on the risk compared to any benchmark stock or index.
When the beta of any given stock = <0, this means that the stock / share / portfolio is moving in the other direction, to the compared benchmark stock / share / portfolio. Often, stocks that have been short sold will show a negative beta value.
If the beta is 0, this means that any given stock / share / portfolio is moving of its own accord, without any regard to other stocks in the area and the growth pattern for this stock / share / portfolio is uncorrelated to the stock market the stock is contained in.
When the beta is in between 0-1, the stock is generally moving up or down as the stock market it is contained in them. However, the beta is less than 1 so the stock isn’t moving at the same speed as the rest of the index. For example, this might be a battery company, where it follows the general pattern of the market but doesn’t fluctuate quite as much. Often, these companies are good to invest in to make slow, relatively low risk investments.
If the beta of a particular stock is 1, the stock / share / portfolio is moving at the same speed and direction of the rest of the index that it is contained in and will pretty much relate exactly to how the rest of the market fluctuates.
Generally, these stocks will be the ones that are contributing to the overall rating of the index and have a serious effect on the rest of the index. Any stock / share / portfolio with a higher beta value than 1 is a risky, strongly influenced stock that may suddenly change in value quickly. If the stock has a beta value of more than 1, the stock will be moving in the same direction as the market, but at a faster rate. These stocks are very likely to be affected by external factors.
Betas can often be calculated by using regression analysis against a suitable base stock or portfolio. For a little more information on regression, this is a highly informative course on regression.
While it is tempting to put a lot of thought and trust in to mathematical relations and analysis of the stock market, it is very unlikely that your predictions will come true. Most of the time, when people make a prediction on a stock they attempt to use figures like beta and technical analysis to see what companies are going to make lot of money and use this information to play the stock market. The problem with these things is that at any time, something could easily change the entire playing field of the market, throwing all prior knowledge to the wind and making any calculations that do not incorporate the new evidence in the calculation useless. As it is impossible to predict the future, it is impossible to predict the stock market due to the huge amount of variables present.
Other methods of dealing in stocks are generally more reliable than beta and mathematical analysis.
In general, most people note that the market you are looking at, has a beta of 1.
The market is moving alongside itself, as you would expect. Beta makes individual stocks rate themselves against the general trend of the market like the S&P 500. Stocks that perform well will get a beta value of above 1 and those that do worse than the general market is going to have a beta of less than 1.
Beta values are useful for investors, assuming they do not base their entire investment strategy on this value. If you have a stock with a beta value of higher than 4 for example, whenever the general index changes by 1%, this stock should change by 4%. Obviously, this means when the stock falls, it plummets and vice versa. Beta provides an at-a-glance view of how risky and possibly profitable any given stock is at the moment in time. The higher the beta, the riskier the stock, with the greater amount of potential profit. Of course, as beta is calculated on the back of regression, some data can throw off the calculations and make the number an oversimplification.
Often, beta values can throw investors off the track, however. Sometimes, beta values can be a bad plan to look at for financial advice, as sometimes, there are beta values that are low, yet end up being more profitable and less risky than those with high beta numbers. We recommend you take your time and find more information about the stocks you are going to invest in, before you make any investments.
The stock market can be very profitable, but you must bare in mind what kind of knowledge is necessary to succeed. As with any new skill, learning to play the stock market is difficult and you are likely to fail the first few times you make an investment. You should always find advice from a broker or take a course in finding good stock options, in the beginning.
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