Understanding Beta

A measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Beta is used in the capital asset pricing model (CAPM), a model that calculates the expected return of an asset based on its beta and expected market returns. It is also known as “beta coefficient”.

Beta is calculated using regression analysis, and you can think of beta as the tendency of a security’s returns to respond to swings in the market. A beta of 1 indicates that the security’s price will move with the market. A beta of less than 1 means that the security will be less volatile than the market. A beta of greater than 1 indicates that the security’s price will be more volatile than the market. For example, if a stock’s beta is 1.2, it’s theoretically 20% more volatile than the market.

Many utilities stocks have a beta of less than 1. Conversely, most high-tech Nasdaq-based stocks have a beta of greater than 1, offering the possibility of a higher rate of return, but also posing more risk.

From this you analysis you could argue that you should always select the stocks with the lowest beta and therefore the lowest volatility compared to the market, however a stock with a low volatility will also in all likelihood have a low risk/reward ratio. The risk/Reward ratio is simply how much risk an investor is willing to take in order to gain the greatest reward possible. If Investor A is risk averse, the investor will shy away from risky investments but will also sjy away from the potential profits. On the other hand, investor B has a bullish investment attitude and  will look to reap the potential rewards but also leaves themselves open to the potential for a large loss. The key is finding the balance between the risk you are willing to take and the associated rewards.

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