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Beta is an important concept in stock market analysis factors. It measures the correlation of a stock versus an index or the market as a whole. Beta also incorporates the volatility of a stock or an entire portfolio, providing valuable data to investors and analysts. Beta indicates either a positive or negative correlation, along with the degree or intensity of the correlation or lack thereof.
Measuring correlation, whether positive or negative, helps investors select, keep or sell individual stocks. Positive correlation indicates that a stock moves with the overall market or the index against which it is measured. Negative correlation suggests that an individual stock tends to move opposite the market or the index. When the market moves up, the stock price moves down if it displays negative correlation. This is expressed as a beta of -1. Positive correlation, a stock price increasing as the market increases, or goes down when the market declines, has a beta of 1.
When you add the component of volatility, a stock might have a beta greater than 1. Even if the stock has a positive correlation with the market, if it is volatile, with wider "swings" up or down, you might witness a stock with a beta higher than 1. A less volatile security, even when moving with the market, could result in a beta less than 1. A highly volatile stock, with dramatic price changes, that has negative correlation could have a higher negative result.
Beta, measuring correlation and volatility, is neither good nor bad. It does give investors valuable information about individual securities. For example, if you prefer stocks that move with the Standard & Poor's 500 and have low volatility, you can find them. Conversely, should your interests lie in securities that move opposite market trends, you'll find those. Examining your entire portfolio against the market may suggest some changes in your portfolio mix. A stock's, or portfolio's, beta can deliver this significant information with just one number.
Some stocks are naturally volatile, usually because the corporations, particularly retailers, experience frequent revenue peaks and valleys. Other securities tend to "creep," with few dramatic highs or lows. Some stocks faithfully follow the market. When the market is up, they are up; when the stock market tanks, they tank. Beta measurements use historical data to predict future events. Beta has no prejudices or preferences. The calculation leaves that to humans. Beta can, however, offer guidance for your current and future investment decisions. Heed its message; then act accordingly.
The beta bottom line is that it measures risk between a stock and the market. Beta is not infallible. For example, a 1.4 beta for a security indicates that it will move, up or down, 1.4 times the historical market move. Depending on your investment strategy, this beta might prepare you for a roller coaster ride to large profits or equally large losses -- or not. Beta, however, delivers valuable information about the risk of profit or loss for the investments you have or contemplate purchasing.
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