Beta is an indicator of the price volatility of a stock or other asset in comparison with the broader market. It suggests the level of risk that an investor takes on in buying the stock. The higher the beta number, the higher the risk.
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While beta measures a stock’s volatility vs. the systematic risk of how the broader market moves, this isn’t the same as volatility in the context of total risk. In this latter case, volatility measures how drastically a stock’s price fluctuates over time when taking into account both systematic risk and unsystematic risk
See Risk for the difference between systematic and unsystematic risk.
The market that the stock trades in, such as the S&P 500, always has a beta of 1.0. A number above one indicates that the stock’s price swings more, up or down, than the market in general. A number below one indicates that its price is more stable.
: the return on an individual stock
: the return on the overall market
Covariance: how changes in a stock’s returns are related to changes in the market’s returns
Variance: how far the market’s data points spread out from their average value
The market used as a benchmark should be related to the stock for beta to provide useful insight.
Beta Values
- Beta equal to 1: A stock with a beta of 1.0 means that its price activity correlates with the market. Adding a stock to a portfolio with a beta of 1.0 doesn’t add any risk to the portfolio, but it also doesn’t increase the likelihood that the portfolio will provide an excess return.
- Beta less than 1: A beta value less than 1.0 means that the security is less volatile than the market. Including this stock in a portfolio makes it less risky than the same portfolio without the stock. Utility stocks often have low betas because they move more slowly than market averages.
- Beta greater than 1: A beta greater than 1.0 indicates that the security’s price is theoretically more volatile than the market. If a stock’s beta is 1.2, it is assumed to be 20% more volatile than the market. Technology stocks tend to have higher betas than the market benchmark. Adding the stock to a portfolio will increase the portfolio’s risk but may also increase its return.
- Negative beta: A beta of -1.0 means that the stock is inversely correlated to the market benchmark on a 1:1 basis. Put options and inverse ETFs are designed to have negative betas. There are also a few industry groups, like gold miners, where a negative beta is common.