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Beta Coefficient

Definition of Beta Coefficient

Beta coefficient is used to measure the volatility of stocks in relation to changes in the market. Basically, Beta helps investors understand the risks associated with a stock compared to the market.

The formula to calculate the Beta coefficient is:

Beta (β) = Covariance (Ri, Rm) / Variance (Rm)

Where:

  • Ri = a stock's return
  • Rm = overall market's return
  • Covariance = ups & downs of stock returns versus ups & downs of market returns
  • Variance = the difference between market returns and its average


Generally, Beta values are of four types:

  • Beta < 1.0: stock less volatile than the market
  • Beta = 1.0: stock just as volatile as the market
  • Beta > 1.0: stock more volatile than the market
  • Negative Beta: stock shares inverse relation with the market

Related Terms

Average True Range Atr

The Average True Range (ATR) is a technical indicator used to measure market volatility, typically using the average of true ranges from 14 periods that can be daily, weekly, monthly, or even intraday values.

The formula for ATR is:

ATR = Previous ATR (n - 1) + True Rangen / n

n= number of periods
True Range = The greater/highest of these:

  • High - low (Day 1)
  • Absolute value of (Day 1’s high - Day 0’s close)
  • Absolute value of (Day 1’s low - Day 0’s close)

Indices

Indices are a collection of financial instruments that measure the performance of those very instruments.

For example, stock market indices like Nifty 50 and Sensex measure the top 50 and 30 stocks by market capitalization.

If indices go up, it generally means that the underlying stocks are performing well. The opposite is true when indices plummet.

By the way, there’s no limit to how many instruments an index can track. The Nifty Smallcap 250 tracks 250 stocks whereas Nifty Bank tracks 12 stocks.

Common Stocks

A common stock is a type of share that gives the holder the right to a part of a company’s profits, voting on key policies and decisions. Common stockholders have an advantage over preferred stockholders because they can:

  • Get higher returns
  • A part of the assets left after a company is liquidated (in case of default)

Arbitrage

Arbitrage is a strategy where a security is bought in one market and sold in another market to generate profits due to the difference in price. This difference is known to be minor.

Say for example a share trades at Rs. 1000 on NSE and Rs. 1002 on BSE. The share can be arbitraged by buying it on BSE and selling it on BSE for a profit of Rs. 2.

Listing

Listing is the process of a private company making its shares available for trading to the public on a recognized stock exchange. To do so, the company meet regulatory requirements and checks. Getting approval means going public and welcoming bids from potential investors.

Illiquid Asset

An illiquid asset is something of value that can not be exchanged for cash easily. Although an illiquid asset may have value, you will not be able to find buyers for it readily. As a result, illiquid assets are typically sold at a significant discount or worse, lose value and expire.



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