What is Beta in the Stock Market?

Before investing in the stock market, there are two key aspects that you need to evaluate in detail. One is the performance or the potential returns you can earn from a stock. The other is the stock’s risk. While it may be easy to assess the returns based on historical data, evaluating risk can be slightly more challenging. This is where the beta in the stock market can be useful. 

In this article, you can learn more about the beta of stocks, what it means, how it is calculated and interpreted and more. 

What is Beta in the Share Market?

The beta in the stock market measures how sensitive a stock is to changes in the market or a specific benchmark index. Denoted by the Greek letter β, the beta of a stock makes it easy to evaluate the systematic risk of the security. In simpler terms, it tells you how much and in which direction a stock’s price is likely to move for every unit change in the market’s movement in a given direction. 

Calculating Beta in the Stock Market

Since the beta of a stock measures its variance or change in relation to the changes in the market, its formula is as follows:

Beta = Covariance of the stock’s returns with the market’s returns ÷ Variance of the market’s returns

Here, the covariance of a stock with the market’s returns indicates how its performance is tied to the market’s movement. If the covariance is positive, it means the stock price rises in a bullish market (and vice versa). However, if the covariance is negative, it means the stock price typically moves in a direction that is opposite to the market. The variance, on the other hand, solely measures the market’ volatility. 

Calculating Beta of a Stock: An Example

Let us discuss a hypothetical example to understand how to calculate the beta value in the share market. Say the covariance of a stock’s returns with the market’s returns is 0.003081 and the variance of the market is 0.009375. 

When we use these values in the formula for beta, we get the following results. 

Beta: 

= Covariance of the stock’s returns with the market’s returns ÷ Variance of the market’s returns

= 0.009375 ÷ 0.003081

​= 0.329

This means that the stock is expected to change by 0.329% for every 1% movement in the market. As you may have gathered, the stock is highly stable and not very volatile. To better understand how to assess the volatility of a stock using its beta, check out the handy beta interpretation guide below. 

Guideline to Interpret Beta of a Stock

You can tell a great deal about the extent and the direction of price movement in a stock based on its beta value. Here is how you can interpret this technical indicator. 

• If Beta = 1 

If the beta of a stock is precisely 1, it means the stock moves exactly as much as the market moves. For instance, if the market (or benchmark index) doubles, so will the stock’s price. It is extremely rare for the beta to be exactly 1, although many large-cap stocks may have beta values close to this limit.

• If Beta < 1

A beta between 0 and 1 indicates that the stock is quite stable. It typically moves less than the market, meaning that its volatility is lower than the market’s volatility. While this may be a good sign for long-term investors, it may not be suitable for traders who want to capitalise on short-term price fluctuations. 

• If Beta > 1 

If the beta of a stock is more than 1, it means the security is more volatile than the market. For instance, if a stock’s beta is 1.70, it means the stock is 70% more volatile than the market. This means you will notice large price movements in the stock for small market movements. While it could lead to higher profits, it also amplifies the risk. 

• If Beta < 0 

A beta less than 0 means you are looking at negative beta values. This simply means that the stock’s price movement is inversely correlated with the market’s volatility. In other words, if the benchmark or the market goes up, the stock will decline (and vice versa). You can use such stocks to hedge your other positions in the market. 

• If Beta = 0

A beta value of 0 means that the asset’s price is not related to the market’s movements. Stocks can never have a beta of 0 because they cannot be unaffected by the market. However, it is common for alternative investments like gold, real estate and art to have a beta of 0 since they are not correlated to the stock market. 

The Significance of Beta for Investors and Traders

The beta value is very useful for investors and traders for various reasons, as outlined below:

• Measuring Volatility

A stock’s beta helps you measure how volatile it is. This is crucial information if you want to check whether the stock aligns with your risk profile. A high-beta stock may not be suitable for conservative investors and traders. 

• Stock Comparison

You can also use the beta to compare different stocks and determine which of them are more volatile when compared with the others. This makes it easier to identify stable or volatile stocks for your portfolio, as per your requirements. 

• Portfolio Diversification

The beta also helps you diversify your equity portfolio across stocks with different levels of volatility. This helps you simultaneously offset extra risk and also tap into the potential for long-term capital appreciation in the stock market. 

The Limitations of Beta in the Stock Market

While the beta is a useful measure of a stock's volatility and its relationship to the broader market, it has several limitations in the stock market, as outlined below:

• Lagging Data

One major limitation is that the beta is based on historical data, so it may not accurately predict future volatility. This is especially noticeable during periods of market instability or when there are significant changes in the stock's fundamentals.

• Limited Risk Considerations

Another limitation is that beta only considers a stock's volatility relative to the market and does not account for other risk factors like company-specific risks or changes in the economic environment. This means that two stocks with the same beta could have very different risk profiles.

• Portfolio Diversification

Since this indicator can be influenced by the period and the benchmark index used in its calculation, it may lead to different beta values for the same stock. This ultimately makes it challenging to compare beta values across different stocks or periods accurately. 

Conclusion

This concludes our guide on beta in the stock market. You can use this data to understand how volatile or stable a stock is and how sensitive it is to market movements. In addition to the beta value, you also need to evaluate other technical indicators like alpha, Sharpe ratio, standard deviation, Treynor ratio and R-squared. This will give you a comprehensive overview of the risk associated with a stock. 

The Motilal Oswal Research 360 platform makes it easy to track the beta of a stock over different periods like 1 month, 3 months, 1 year and 3 years, so you get holistic insights into a stock’s short-term, medium-term and long-term volatility and risk. To find this information, all you need to do is search for the stock you are interested in, navigate to the ‘Technical’ section and check the beta values. In addition to this crucial information, the Motilal Oswal Research 360 platform also shows various other details like trading volume, price performance, moving average, pivot points and more.