It measures the systematic risk of a security or a portfolio compared with an index like the S&P 500. Many growth stocks would have a beta over 1, probably much higher. A Treasury bill would have a beta close to zero because its prices hardly move relative to the market as a whole. Alpha measures a portfolio’s performance relative to a benchmark index.
A 2X leveraged S&P 500 ETF has a beta very close to two relative to the S&P 500 by design. It goes up or down twice as much as the index in a given period of time. If beta is forex compounding calculator -2, then the investment moves in the opposite direction of the index by a factor of two. Most investments with negative betas are inverse ETFs or hold Treasury bonds. Likewise, low-beta stocks may be less volatile than the market but could still outperform or underperform market averages over the specified period.
Alpha vs. Beta: An Overview
The maker of household brands such as Pampers, Oral, Pantene, and Gillette, as of June 2024 has a five-year beta of 0.42. In other words, its share price fluctuates much less than the broader market. For every 1% move in the market, Proctor & Gamble’s shares moved 0.42% on average. That’s good in terms of protecting against losses but also means limited upside potential compared to other options.
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Adding this type of stock to a portfolio will raise its risk, but it may also improve its expected return. A stock with a very low beta could have smaller price swings, yet still be in a long-term downtrend. So, adding a down-trending stock with a low beta decreases the risk in a portfolio only if the investor defines risk strictly in terms of volatility and not potential losses. Essentially, beta expresses the trade-off between minimizing risk and maximizing return. On the other hand, if the market declines 6%, investors in that company can expect a loss of 12%. Value investors scorn the idea of beta because it implies that a stock that has fallen sharply in value is riskier than it was before it fell.
An investor uses beta to gauge how much risk a stock adds to a portfolio. While a stock that axes broker deviates very little from the market doesn’t add a lot of risk to a portfolio, it also doesn’t increase the potential for greater returns. A company behind the next big thing typically commands a high valuation.
What Is the Relationship Between Alpha and Beta?
It’s generally used as both a measure of systematic risk and a performance measure. The beta for a stock describes how much the stock’s price moves compared to the market. If a stock has a beta above 1, it’s more volatile than the overall market. For example, if an asset has a beta of 1.3, it’s theoretically 30% more volatile than the market.
Beta values can shift over time because they’re tied to market fluctuations. Investors use beta to align their portfolios with their risk tolerance levels, targeting high-beta stocks for potentially higher returns with more risk, or low-beta stocks for added stability. Beta is used in the capital asset pricing model (CAPM), a widely used method for pricing risky securities and for generating estimates of the expected returns of assets, particularly stocks. The CAPM formula uses the total average market return and the beta value of the stock to determine the rate of return that shareholders How to buy digibyte might reasonably expect based on perceived investment risk.
- It’s not a forward-looking metric, so take the time for fundamental research to augment your analysis.
- You’ll find this alongside other metrics of a stock’s price when doing your research — which you should always do.
- Our estimates are based on past market performance, and past performance is not a guarantee of future performance.
- Many brokerage firms calculate the betas of securities they trade and then publish their calculations in a beta book.
- No matter how good or bad the economic indicators are, people are going to continue to buy Tide detergent and Olay soap in roughly the same amounts.
It can show the relationship between a hedge fund’s returns and the market return. Beta can show how much risk the fund is taking in certain asset classes and can be used to measure against other benchmarks, such as fixed income or even hedge fund indexes. This measure can help investors determine how much capital to allocate to a hedge fund or whether they would be better off keeping their exposure in the equity market or even cash. Beta is a statistical measure of the volatility of a stock versus the overall market.
