What is beta in investments?
In investing in stocks or for that matter in the whole investment space, volatility or risk is determined using a metric called a beta value. This is calculated against the benchmark. The beta of the benchmark index is 1 while that of the FCP or the script is always specified.
How to calculate the beta?
In the stock market, a script’s beta suggests the rate or pace at which the script moves in tandem with the overall market movement. The beta formula is calculated as follows:
Covariance of a specific security against the benchmark / Script variance over a defined period.
Risk-reward potential of high beta stocks
In a bull market, like the current situation, betting on high beta stocks can be lucrative and potentially generate higher returns for investors. In a weakening market, however, any sharp drop can be detrimental to investors’ portfolios if they include more high beta stocks.
Indian stocks beta
Mainly beta for Indian stocks can be of 4 types:
1. Beta greater than 1:
The action or the investment evolves here more in line with the benchmark, that is to say shows a great reactivity. Thus, small and mid caps with the potential to generate higher returns fall into this category. However, in a weak market, due to weak fundamentals, these companies are not sufficiently capitalized to cover the loss. For example, if the stock’s beta is 1.4, then it is 40% more volatile than the market.
2. Beta less than 1:
These stocks have a parallel effect with the movement of the price of stocks in a manner similar to benchmarks. Large cap companies have a beta value of 1
3. Beta is 0
Here the scripts or investment options do not show any price movement relative to the market e.g. bank FDs, bonds etc. Investors who need to protect their capital can invest in instruments with zero beta value.
4. The beta is negative
These are investments that work against the movement of the stock market. These investment options are often referred to as safe havens such as US dollars, gold, etc.
Who Should Be in Beta Investments?
First and foremost, the risk profile of a person or an investor will be a deciding factor in deciding which beta investment to choose. While risk averse investors should opt for securities with a beta value of zero or less than 1, those with a higher risk appetite may opt for a high beta value or investments with a beta value greater than 1. .
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