Definition
Beta measures how sensitive an asset's returns have been to the returns of a market benchmark: a beta of 1 means it moved in line with the market on average, above 1 more, below 1 less.
How it works
The formula is beta = covariance(asset, market) ÷ variance(market). Covariance measures how two series of returns move together, and variance measures how much the market's returns spread out. An equivalent form is beta = correlation × (asset volatility ÷ market volatility). Both are calculated from past returns over a chosen period against a chosen benchmark, often a broad stock index.
A beta of 1.5 means that during the measured period the asset moved about 1.5 times as much as the market on average, in the same direction. A beta of 0.5 means about half as much, and a negative beta means it tended to move in the opposite direction. Investors use beta to estimate how strongly market-wide swings affect a stock or a portfolio.
Beta has limits. Different periods, return frequencies and benchmarks produce different betas for the same stock, so data sites often disagree. It describes the past, and a company's sensitivity can change. Low beta is also not the same as low risk: a stock with weak correlation to the market can have a low beta yet large price swings of its own.
Example (hypothetical numbers)
Suppose that over the past 2 years the daily returns of Stock X and a market index have a covariance of 0.00030, and the index's daily returns have a variance of 0.00020.
Beta = 0.00030 ÷ 0.00020 = 1.5, so on a day the index rose 2%, Stock X tended to rise about 1.5 × 2% = 3%.
Stock Y has a correlation of 0.2 with the index and annual volatility of 60%, versus 20% for the index: beta = 0.2 × 60% ÷ 20% = 0.6.
Stock Y has the lower beta, yet its own price swings are 3 times as large as the index's.
Common mistakes
- Treating a low beta as proof that a stock is safe.
- Comparing betas from sources that use different periods or benchmarks.
- Assuming a beta measured in the past will stay the same in the future.
Related calculators
This glossary is for education only and is not investment advice. Examples use hypothetical numbers.