Beta
Explanation
Beta quantifies the systematic risk of a security or portfolio—the portion of risk that cannot be diversified away. A beta of 1.0 means the investment moves in lockstep with the market. A beta above 1.0 indicates amplified moves; below 1.0 indicates dampened moves.
Beta is calculated by regressing a stock's returns against market returns over a defined period, typically 60 months of monthly data or 252 trading days of daily data. The slope of that regression line is beta.
For portfolio construction, beta is a lever. Want more upside capture in bull markets? Tilt toward high-beta stocks. Want stability in drawdowns? Reduce average portfolio beta below 1.0. The trade-off is straightforward: high beta amplifies both gains and losses.
Formula
| Variable | Meaning |
|---|---|
| β | Beta of the security |
| Cov(Ri, Rm) | Covariance between security returns and market returns |
| Var(Rm) | Variance of market returns |
Example
A stock has a beta of 1.3 relative to the S&P 500. The market drops 10% in a correction.
The stock is expected to fall 13%—3 percentage points more than the market. In an up market of +10%, the same stock would be expected to rise 13%. This amplification is the core trade-off of high-beta exposure.
How Stoquity Uses This
Stoquity displays beta on every portfolio dashboard and uses it in the risk model to ensure no portfolio exceeds its charter-defined beta ceiling. The Drawdown Governor automatically reduces position sizes when portfolio beta drifts above target.
Common Mistakes
- Beta measures direction of sensitivity, not magnitude of total risk—a stock can have low beta but high total volatility from idiosyncratic events
- Beta is backward-looking and can shift as a company's business mix changes
- A beta of 0 does not mean zero risk—it means zero correlation with the market index