Sid Hopps
Apr 20, 2023
Beta is a way of measuring an asset’s volatility compared with the overall market’s volatility. By definition, the market as a whole has a beta of 1, and everything else is defined in relation to that:
Beta is a way of measuring an asset’s volatility compared with the overall market’s volatility. By definition, the market as a whole has a beta of 1, and everything else is defined in relation to that:
Assets with a value greater than 1 are more volatile than the market, meaning they will generally go up more than the market goes up, and go down more than the market goes down.
Assets with a beta of less than 1 have a smoother ride as their moves are more muted than the market’s, but they’ll usually still go up when the market goes up and down when the market goes down.
Assets with a negative beta, which is unusual, will typically move inversely to the market. So when the market goes up, these securities fall, and vice versa.
Pros and cons of using beta
Pros
History can hold important lessons: Beta uses a sizable chunk of data. Typically reflecting at least 36 months of measurements, beta gives you an idea of how the stock has moved vs. the market over the last three years.
Numbers don’t lie: Rather than combing through press releases or news about past events, and how the asset reacted to these various pieces of news, beta mathematically represents the assets’s moves for you.
Cons
You’re looking in the rearview mirror: Beta is a backward-looking, singular measure that doesn’t incorporate any other information. It’s good to reflect on what the past three years looked like, but as an investor, what you care about is what’s in store for the next three years. You want to think about the business environment and potential market shifts on the horizon. Betas can and do change over time. That’s why beta is only one part of your research.
Numbers aren’t everything: Beta doesn’t include qualitative factors that can play a significant role in an asset’s outlook. Perhaps the future will look quite a bit different, so portfolio construction is an important part of systematic portfolio trading.
We carefully consider the beta of assets we trade in order to tactically reallocate capital between asset classes while also measuring their trends.