Why Calculating Beta of a Stock is Helpful

Many people think that calculation of beta of a stock is helpful only for portfolio manager, which is not the case. Knowledge of a beta of a stock can be helpful even for a small investor.

Beta is a term which is used with respect to stock market; it measures the risk which is non diversifiable or systematic risk of the stock in relation to the market. Beta can be calculated as co-variance between security returns and market return divided by variance of market return.

If beta of stock is more than 1 then it is considered as aggressive or risky security, if it is less than 1 then it is considered as defensive security and if it is 0 then it implies that its price is not at all correlated with the market.

As an investor if one is bullish about the market as a whole then he or she should buy the high beta stock because if market rise by 10 percent then high beta stock will rise more than 10 percent, while low beta stock will rise less than 10 percent. However if an investor feels that market will fall then he or she should buy a low beta stock because they will fall less as compared to high beta stock. In other words, in bull market those investors who invested in high beta stocks will get superior returns while in bear markets those investors who have invested in low beta stocks will be better off.

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