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| Beta Values and What They Mean | |
|---|---|
| Beta | Meaning |
| 1.0 | The stock moves in line with the broader market |
| 2.0 | The stock moves twice as much as the broader market |
| 0.0 | The stock’s moves don’t correlate with the broader market |
| -1.0 | The stock moves in perfectly inverse versus the broader market |
Tip
A stock has a negative beta if its price moves in the opposite direction of the market. A stock with a beta of -0.5, for example, would drop 0.5% for every 1% rise in the broader market.
Calculating the Beta for a Stock
It’s easiest to just check the stock’s webpage to find its beta, but an investor can calculate the number. There are several steps:
- Step 1 -Compile Historical Price Data: Obtain historical price data for both the stock and the market index.
- Step 2- Calculate Periodic Returns: Using the price data, calculate the returns for the stock and the market index over the chosen time frame.
- Step 3- Compute the Covariance between the Stock and the Market: Calculate the covariance between the stock’s returns and the market’s returns. Covariance indicates how the returns of the stock and the market move together.
- Step 4- Calculate the Variance of the Market Returns: This calculation represents how much the market returns fluctuate over time.
- Step 5- Calculate the Beta: Using the covariance calculated in steps 4 and 5, the beta is calculated as follows: Beta = Covariance (Stock Returns, Market Returns) / Market Variance
High Beta vs. Low Beta: Which Is Better?
The higher the potential reward, the higher the risk. That is a common belief among investors.
High-beta stocks are expected to provide higher potential returns because they carry more risk. Low-beta stocks offer lower potential returns because they carry less risk.
Which is best depends on what type of investor you are.
More conservative investors, including those who want to tap into their funds soon, tend to prefer low-beta stocks. Many companies consistently deliver steady revenues and profits both in times of economic expansion and contraction. Positive or negative surprises are minimal and valuations are based on realistic earnings expectations.
Investors keen to bag big short-term gains, including day traders, are more interested in high-beta stocks. Their share prices tend to jump around a lot, offering opportunities to cash in. You could make a fortune or lose one. Innovative tech startups usually fall into this category.
Higher beta stocks also tend to outperform in bull markets when the economy is in expansion mode and confidence is high. Lower beta stocks tend to fare better during recessions.
Important
A stock’s beta changes over time as a company matures or runs into trouble and as overall market conditions change.
Low Beta Stock Example
Low-beta stocks tend to be defensive stocks. There is a constant demand for their products or services, regardless of the economic cycle, resulting in steady profits and revenues, which often translate into a steady share price and regular dividend payments.
A classic example of a low-beta stock is Proctor & Gamble. The maker of household brands such as Pampers, Pantene, and Gillette had a five-year beta of 0.41 as of May 2025.
In other words, its share price fluctuates much less than the broader market. For every 1% move in the market, Proctor & Gamble’s shares moved 0.41% on average. That’s good in terms of protecting against losses though it also means limited upside potential compared to other options.
High Beta Stock Example
High beta is generally associated with small companies and growth stocks. These are companies that are expected to increase their revenues and their profits fast. They have shown enough promise to draw speculative investors looking for big returns.
Many of the highest beta stocks are young tech companies. A company behind the next big thing typically commands a high valuation. Investors buy the stock hoping it lives up to its potential. High hopes create volatility. A slip-up could cause the share price to tumble dramatically. Likewise, a hint of good news can lead to a big rally.
Tesla falls into this category. There is a lot of hope baked into its share price, resulting in wild swings whenever it makes the news cycle. Tesla’s five-year beta was 2.43 in May 2025.
Advantages of Using Beta as a Proxy for Risk
Beta is useful to followers of CAPM. If you think about risk as the possibility of a stock losing its value, beta has appeal as a proxy for risk.
Intuitively, it makes plenty of sense. Think of an early-stage technology stock with a price that bounces up and down more than the market. It’s hard not to think that stock will be riskier than, say, a safe-haven utility industry stock with a low beta.
Beta offers a clear, quantifiable measure that is easy to work with.
Tip
Beta is generally more useful to traders moving in and out of stocks frequently than it is for investors with long-term horizons.
Disadvantages of Using Beta as a Proxy for Risk
The definition of risk is the possibility of loss. Of course, when investors consider risk, they are thinking about the chance that the stock they buy will fall in value.
The trouble is that beta, as a proxy for risk, doesn’t distinguish between upside and downside price movements. For most investors, downside movements are a risk, while upside ones mean opportunity. Beta doesn’t tell an investor which the stock is likely to experience.
Value investors scorn beta because it implies that a stock that has fallen sharply in value is riskier than it was before it fell. A value investor would argue that a company represents a lower-risk investment after it falls in value because investors can get the same stock at a lower price.
Beta says nothing about the stock’s price relative to fundamental factors like changes in company leadership, new product discoveries, or future cash flows. For value investors, that’s a problem.
Consider a utility company: Let’s call it Company X. Company X has been considered a defensive stock with a low beta. If it entered the merchant energy business and assumed more debt, X’s historic beta would no longer capture the substantial risks the company just took on.
It’s also worth noting that newer stocks have insufficient price history to establish a reliable beta.
Warning
Beta is based on past price movement and the past doesn’t necessarily have a bearing on the future.
Another troubling factor is that past price movement is a poor predictor of the future. Betas are rear-view mirrors, reflecting nothing that lies ahead.
Furthermore, the beta measure on a single stock tends to flip around over time, which makes it somewhat unreliable. Granted, for traders looking to buy and sell stocks within short periods, beta is a fairly good risk metric. For investors with long-term horizons, it’s less useful.
Advantages and Disadvantages of Using Beta
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Risk Assessment: Beta quantifies a stock’s sensitivity to market movements, helping investors gauge risk.
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Portfolio Diversification: Using beta to choose a variety of stocks can help an investor diversify to withstand market downturns.
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Benchmark Performance: A stock’s beta clarifies how much of its volatility is due to market factors rather than individual performance.
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Historical Nature: Beta is a backward-looking, meaning it is calculated based on historical returns and may not accurately predict the future.
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Ignores Fundamental Factors: Beta ignores a company’s fundamentals such as its earnings growth.
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Market Dependency: Beta assumes that volatility relative to the market is the primary driver of risk, which may not apply in every case.
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Linear Relationship Assumption: Beta assumes a linear relationship between the stock and the market, which might not hold in extreme market conditions.
The Differences Between Alpha and Beta
Both alpha and beta help investors assess the performance and risk of investments relative to the market. While beta measures a stock’s sensitivity to market movements, alpha is about performance beyond market movements.
Positive alpha signals strong returns driven by skill or unique factors independent of market trends.
Beta focuses on systematic risk, while alpha measures idiosyncratic performance. Traders use beta to manage the portfolio’s vulnerability to market swings, and then incorporate alpha to reveal whether the trades add value beyond those market movements.
Beta Trading Strategies
There are high-beta strategies that focus on stocks with a beta significantly higher than 1, giving investors a chance for high returns in good times (and high losses in bad times).
Low-beta strategies prioritize stability and downside protection by focusing on defensive stocks.
More advanced strategies, called market-neutral strategies, balance long and short positions to eliminate the impact of beta. There also are beta rotation strategies that shift between high- and low-beta assets based on market direction, requiring some level of market timing.
Other approaches include smart beta strategies, which target specific risk factors such as value or momentum.
Do Beta and Alpha Correlate?
While alpha and beta are not directly correlated, market conditions and strategies can create indirect relationships.
What is the Advantage of Buying High-Alpha but Low-Beta Stock?
High-alpha, low beta stocks provide outperformance and portfolio stability. This combination tends to improve portfolio diversification, reduce risk, and create smoother and more consistent returns.
Can Beta be Negative?
Yes, beta can be negative but it is rare for stocks. A negative beta indicates that an asset moves inversely to the market. Negative beta assets help stabilize portfolio returns and offset risks.
The Bottom Line
Beta is the volatility of a security or portfolio compared to its benchmark. It’s a numerical value that signifies how much a stock price jumps around over time. The higher the value, the more the stock tends to fluctuate in value.
Ultimately, it’s important to make the distinction between short-term risk—where beta and price volatility are useful—and longer-term, fundamental risk, where big-picture risks are more likely to come into play.
High betas may mean price volatility over the near term, but they don’t always rule out long-term opportunities.
