Beta: The Measure of Stock Risk
The risk of stocks has a special name in the world of finance – beta. The simplified explanation of beta is that it tells you how the value of a stock moves up and down with an index like the S&P 500. You don’t really have to know how it is calculated, but knowing the beta for each stock gives you an idea of how risky it is. If a stock has a beta of 1, it means that its value moves up and down by the same percentage as a market index like the S&P 500. A stock that moves with this index is said to have the same risk as the market.
For example, if the S&P 500 index has a value of 5,000 today and moves to 5,500 tomorrow, this represents a 10% increase. If the stock of company XYZ has a beta of 1, you would expect its value to also increase by approximately 10%. A stock like this with a beta of 1 is not really considered risky when compared with the overall stock market.
A stock with a beta of, say, 2 means that each time the S&P Index moves up by 10% or so, the stock of company XYZ moves up by 2 x 10% = 20%. It also means that this same stock can move down 20% in value if the S&P drops 10%. So in general, high beta stocks are riskier than low beta stocks. But some people like risk because, even though they can lose a lot of money, they can also gain a lot if the market goes their way.