What is a beta and how to calculate it

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Saurabh Guptahttp://karekaise.in
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The higher the risk, the higher the return.” This is a common saying related to the stock market. When it comes to risk in the stock market, a lot of investors talk about beta factor but what is beta (what is beta in stock market)?Today in this article we will know what is a beta and how to calculate it?

 What is beta in stock market

 Every person entering the stock market expects to earn a high return on his invested amount. However, stocks with higher potential returns also carry the risk of losing money or falling in price.

In this situation, investors should have some option or the other to analyze their risk appetite and limit the stock market risk.

But how to know which stocks have high risk and which stocks are low? Beta removes this dilemma. Using a popular indicator in the stock market called beta helps an investor in estimating risks.

Beta is an indicator in the stock market that is used by investors to assess the risk associated with a specific stock. It allows investors to measure the volatility of the stock and ensure that they adjust their positions or buy/sell the stock.

Beta material in the stock market works by estimating the risk of a stock in relation to the stock market.

For example, beta in the stock market defines the risk of a stock relative to a stock market index like Nifty, Sensex, etc. If the index is rising but the stock price is falling, the investor can gauge this risk through beta.

How to calculate beta?

A beta coefficient measures the volatility of an individual stock compared to the systematic risk of the stock market as a whole. This data point represents the slope of the line through regression. These data points represent the returns of individual stocks against the market as a whole.

The beta method assigns a value of 1 to a comparable index like Nifty or Sensex. Subsequently, individual stocks are ranked above or below 1, depending on how much they deviate from the market’s performance or the index.

If the rank assigned to a particular stock is above 1, it means that the stock is outperforming the market and is called a high beta stock. However, if the ranking is below 1, it means that the stock is moving slower than the overall market and is called a low beta stock.

Beta is represented as:

Beta Coefficient (β) = Covariance(Re, Rm) / Variance(Rm)

According to this equation,

  • Re = Return on an Individual Stock
  • Rm = Return on Overall Market
  • Covariance = How the change in a stock’s return is related to the change in the market’s return.
  • Variance = How far the data points of the market are spread from their average price.

types of beta in stock market

There are four types of betas in the stock market, which help investors understand the risks associated with stocks:

β>1: A stock has more than one beta price means that it is outperforming the market as a whole. These stocks are called high beta stocks and investors expect to earn substantial returns in it. However, such high beta stocks are accompanied by a high risk factor with the possibility that the price could crash at any time with the current market average.

β<1: A stock with a beta value of less than 1 means that they are underperforming or underperforming the overall market. These stocks are called low beta stocks and they help in earning low but steady returns to the investors. Such stocks are low risk and considered stable against market volatility.

β=1: A beta equal to a stock indicates that the stock is ideally correlated to the stock market or index. These stocks are also considered stable and have a parallel effect on returns with stock price and market volatility as a comparative index. Generally, shares of large-cap companies in the stock market have a beta equal to one because these companies form the major part of the index.

β<0: Securities other than stocks have a beta value of 0 as compared to the stock market index. For example, gold is a commodity that may have a beta value of 0, indicating that its price may rise over time, regardless of how the stock market indexes are performing. Investors use these securities to hedge against stock market crashes.

Who Should Invest in Beta Stocks?

The beta of shares in the Indian stock market helps investors to assess the risk factor associated with the respective securities. Investors who are risk-averse can invest in stocks with a beta price of more than 1 to ensure adequate returns on the portfolio. However, such investors should be prepared to bear huge losses in case of unforeseen circumstances.

Typically, shares of small-cap and mid-cap companies have a beta price of more than 1, because of their wider growth potential. Buying stocks or bonds from such businesses can create substantial wealth through significant annual returns.

On the other hand, risk-averse investors or low-risk investors can opt for a stock beta of less than 1. Fixed return instruments are usually linked to such beta values, as the returns of the respective instruments are not directly affected by stock market volatility.

When the beta value of the shares is 1, indicating the same volatility rate between the index and the related securities. Large-cap companies often have a beta equal to 1, as these companies are a major part of Indeco.

Although investments in such securities may not yield substantial returns, high-value dividend payments often create wealth for investors. It is better to invest in such companies as they have the financial backing to deal with the downturns of the business cycle which, in turn, ensures no steep fluctuations in the stock price.

Benefits of using beta

History can take an important lesson: The stock market uses a large portion of beta data. Reflecting a measurement of at least 36 months, beta gives you an idea of ​​how the stock has fared against the stock market over the past 3 years.

The numbers don’t lie: rather than making investment decisions about a company’s past product launches via press releases or what the company’s CEO might have said at Investor Day last year, and how the stock has reacted to these various news stories. . Apart from all this you must trust the data because data never lie. Beta represents the movement of the stock to you mathematically.


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