Weekly Lesson Wednesday📝 

Whats Beta in Finance ❓

^_Lesson
Be Alpha and use Beta

Today’s lesson is all about Beta. How to use it and all that good stuff, and no I’m not talking about getting some nerd to do all your work. Although, that also could be useful.

So, whats the deal. What is Beta ?

Lets take an investment security like a stock. Beta (denoted by β) is a gauge of the volatility or systematic risk of a stock compared to the market (usually the S&P). It is used in the capital asset pricing model (CAPM), which describes the relationship between systematic risk and expected return for assets.

Take this analogy to fully understand it. Imagine two roller coasters: one is the "Thunder Coaster," which is wild with lots of ups and downs, sharp turns, and high speeds. The other is the "Mellow Coaster," which is much gentler, with smaller hills and slower speeds.

In this analogy:

• The "Thunder Coaster" is like a high-beta stock. Just as this roller coaster has extreme ups and downs, a high-beta stock experiences large swings in its price, reacting strongly to changes in the overall market.

• The "Mellow Coaster" is like a low-beta stock. This roller coaster has smaller, more manageable hills and turns, just as a low-beta stock has smaller, more stable price movements, not reacting as dramatically to market changes.

Beta, in this sense, tells you how thrilling (or risky) the ride is going to be.

A higher beta means more excitement and potential for big gains (or losses), while

A lower beta means a smoother, more predictable experience.

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5 steps to calculate Beta (β)

👉 STEP 1: Collect Historical data 

First thing you need is the data. You will want to download the historical prices of your asset or stock you want to calculate β for and the historical prices for the benchmark you want to compare with, usually the S&P or Dow Jones. You will need at least 2 years of data for useful results. Downloading this data is easily done on sites like Yahoo Finance.

👉 STEP 2: Calculate Returns

Calculate the daily or monthly returns for the stock and benchmark index. The return is calculated as follows

👉 STEP 3: Calculate the Covariance

To calculate the covariance you will need data like returns on stocks and benchmarks. However, most spreadsheet applications like excel or google sheets have this built in and you can just use there with your figures. So it will be the covariance function used on the return figures you got for your stock and benchmark.

👉 STEP 4: Calculate Variance

To calculate the variance you will need to use this formula. Same goes for variance as covariance. It will be built in to the spreadsheet.

👉 STEP 5: Calculate Beta

Now just put it together.

A beta of 1 means the stock tends to move in line with the market.

A beta greater than 1 means the stock is more volatile than the market,

A beta less than 1 means it's less volatile.

Thank you
That’s All Folks

Thank you for reading. Like usual. Not financial advice.

Full disclaimer here

Cheers,