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Understanding Beta: A Key Metric for Investors

Nick Schmidt
Nick Schmidt

Nick Schmidt is a co-founder of TraderLion and Deepvue with over 10 years of market experience. Adopting a “less is more” philosophy, he focuses on weekly charts with an emphasis on price and volume.

Published: December 2, 2023

4 min read

What Is Beta?

Beta is a key financial metric that shows how much a stock’s price tends to move compared to the overall market. Think of it as a measure of market risk—it helps investors understand how volatile or stable a stock might be in different market conditions.

Here’s how it works:

  • A Beta of 1 means the stock generally moves in line with the market. If the market goes up 5%, the stock might also rise around 5%.
  • A Beta above 1 indicates higher volatility. For example, if a stock has a Beta of 1.5, it could rise 7.5% when the market gains 5%, but it might also fall more sharply if the market drops.
  • A Beta below 1 suggests the stock is less sensitive to market swings. These stocks may offer more stability but often come with lower potential returns.

Beta is also a core part of the Capital Asset Pricing Model (CAPM), which investors use to estimate a stock’s expected return based on its Beta and other factors. By understanding Beta, investors can better assess the risk and reward of a stock and choose stocks that match their risk tolerance and market outlook.

Why Is Beta Important for Investors?

Beta is a powerful tool for investors to understand and control risk. It shows how much a stock or ETF moves in relation to the overall market, typically measured against benchmarks like the S&P 500. By understanding Beta, you can make smarter decisions about risk, diversification, and portfolio management.

Here’s how Beta helps:

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  • Measure Risk: Beta lets you gauge a stock’s risk by showing how closely it tracks the market. A high Beta means the stock is more volatile than the market; a low Beta means it’s more stable. If you want to avoid high-risk securities, Beta can help you spot them and understand your portfolio’s overall exposure to market swings.
  • Diversifying Your Portfolio: Beta is key for building a balanced portfolio. By mixing assets with different Beta values, you can spread out risk. For example, adding lower-Beta assets like bond ETFs can reduce overall volatility, while assets with negative Beta can act as a hedge if the market drops. Beta helps you pick a variety of assets to create a stable, diversified portfolio. However, if you are a growth investor, a popular William O’Neil quote says “Over-diversification is a hedge for ignorance.” The CANSLIM methodology encourages concentrating your portfolio into a few strong stocks at a time to maximize performance.
  • Managing Your Portfolio: Beta helps you see how each asset affects your overall risk and return. By balancing high and low Beta assets, you can tailor your portfolio to match your risk tolerance and goals. Take investor Mark Minervini, the creator of the popular Volatility Contraction Pattern, for example. He keeps his portfolio’s Beta low—around 0.43—far below the market average. This keeps volatility in check while still allowing for high returns. Minervini’s strategy proves that a low-Beta portfolio can still deliver strong results when you’re selective and disciplined with your stock choices.

How Is Beta Calculated?

Beta is a key risk metric for investors. It shows how much a security’s price moves in relation to the market. You can calculate Beta in two main ways: with historical data or through regression analysis. Both methods help assess the security’s risk and gives investors valuable insights to make smarter choices.

Beta Calculation Formula

Most platforms such as Deepvue automatically calculate and display beta for every stock.

High Beta Stocks vs. Low Beta Stocks

  • High Beta Stocks: These stocks are more volatile and swing more than the market. They come with higher potential returns but also greater risk.
  • Low Beta Stocks: These stocks are less volatile, providing more stability. While their returns may be lower, they’re generally seen as safer investments.

Frequently asked questions

High-Beta stocks are more sensitive to market fluctuations, meaning they swing more dramatically up or down with the market. This makes them riskier but potentially more rewarding. Low-Beta stocks, on the other hand, tend to move less than the market, offering more stability but often with lower returns.

Successful investors like Mark Minervini use Beta strategically to manage volatility while aiming for high returns. Minervini keeps his portfolio’s Beta low (around 0.43) to limit downside risk, but he selectively chooses stocks with strong growth potential. His approach shows that a low-Beta portfolio doesn’t have to sacrifice performance. By carefully selecting stocks with high potential but low overall portfolio Beta, you can maintain a balanced strategy with both stability and growth.

A Beta of 1 means the stock typically moves in line with the overall market. If the market rises or falls by a certain percentage, a stock with a Beta of 1 is expected to move by a similar percentage. For example, if the market gains 5%, a stock with a Beta of 1 might also rise around 5%. This indicates average volatility—neither more nor less volatile than the broader market.

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