Beta is a term that gauges a security’s volatility relative to the broader market as well as to understand a risk associated with a stock in question. The wider market has a beta of 1, which means that stocks that have a beta of more than 1 are more volatile than the broader market.
To give an example, if a stock has a beta of 1.2, it essentially means that this stock is 20% more volatile than the broader market. If a stock has a beta of 1, it indicates that the stock carries the same volatility as the market. Beta is usually calculated by regressing the percentage change in stock prices against the percentage change in the broader market.
Beta is one of the key parts of the Capital Asset Price Model (CAPM) which gauges the return of a security. By calculating a stock’s beta, investors and analysts can measure the volatility and the systematic risk of that stock. If a stock has a positive beta, it suggests that the stock generally trends in the same direction as the market and the other way around.
As a general rule of thumb, defensive stocks have a low CAPM beta, while cyclical and growth stocks normally have a high CAPM beta.
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