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Photo Credit: Peter Hellberg

Photo Credit: Peter Hellberg

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The Meaning of Beta

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The Meaning of Beta

The risk of stocks has a special name in the world of finance--beta. The simplified explanation of beta is that it tells you how the value of a stock moves up and down with an index like the S&P 500. You don't really have to know how it is calculated but knowing the beta for each stock gives you an idea of how risky it is.

If a stock has a beta of 1, it means that its value moves up and down by the same percentage as a market index like the S&P 500 moves up and down. A stock that moves with this index is said to have the same risk as the market. For example, if the S&P 500 index has a value of 5,000 today and moves to 5,500 tomorrow, this represents a 10% increase. If the stock of company XYZ has a beta of 1, you would roughly expect its value to also increase by approximately 10%.

A stock with a beta of 1 is not really considered risky when compared with the overall stock market. A stock with a beta of, say, 2 means that each time the S&P Index moves up by 10% or so, the stock of company XYZ moves up by 2 x 10% = 20%. It also means that this same stock can move down 20% in value as well. So in general, high beta stocks are riskier than low beta stocks. But some people like risk because, even though they can lose a lot of money, they can also win a lot if the market goes their way.

 


Photo Credit: Mitya Ku

Photo Credit: Mitya Ku

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