Wednesday, October 6, 2010
The Beta Coefficient is a means of measuring the volatility of a security or of an investing portfolio of securities in comparison with the market as a whole.
Beta is calculated using regression analysis. A Beta of 1 indicates that the security's price will move with the market. A Beta greater than 1 indicates that the security's price will be more volatile than the market and finally, a Beta less than 1 means that it will be less volatile than the market.
Beta values can be roughly characterized as follows:
* Beta Equal to 0: Cash under your mattress, assuming no inflation.
* Beta Between 0 and 1: Low-volatility investments (e.g., utility stocks).
* Beta Equal to 1: Matching the index.
* Beta Greater than 1: Anything more volatile than the index.
Most new high-tech stocks have a Beta greater than one, they offer a higher rate of return but they are also very risky. The Beta is a good indicator of how risky a stock is.
The more risky a stock is, the more its Beta moves upward. A low-Beta stock will protect you in a general downturn.
That's how it is supposed to work, anyway. Unfortunately, past behavior offers no guarantees about the future. Therefore, if a company's prospects change for better or worse, then its Beta is likely to change, too.
So, be extremely cautious and use the Beta Coefficient only as a guide to a stock's tendencies.
Stocks and the Beta Coefficient