What is Beta?
In investing, the Greek letter beta is used when describing the extent to which the value of a given security is affected by changes to the market as a whole.
The baseline measurement of beta is 1. If a stock or other security has a beta value of 1, then the security moves with the market as a whole.
Stocks or other securities with beta measurements greater than 1 are more volatile than the market as a whole.
Stocks or other securities with beta measurements less than 1 are less volatile than the market as a whole.
Think of beta as a measurement of impressionability. Stocks and other securities that are highly impressionable will have a high beta and will be unable to stay steady in the face of volatile market conditions. Their volatility levels will exceed those of the market as a whole.
Meanwhile, low beta securities are less impressionable and are more likely to remain steady in a volatile market.
Higher beta is not necessarily bad. Though higher beta stocks may be riskier, they often offer greater reward potential.
Smaller cap stocks generally have higher betas than large cap stocks.
The Importance of the R-squared Measurement in Assessing Beta
To minimize the confusion of correlation for causation, a measurement called R-squared is used to assess the percentage of any given security’s price movements that can be fairly attributed to more broad and general market movements.
An R-squared measurement can be used for instance to assess the extent to which fluctuations in General Motors [NYSE: GM] have closely correlated with fluctuations in a given market benchmark, such as the Dow Jones Industrial Average. The higher the R-squared measurement in relation to its benchmark, the more accurate the beta measurement should be.
Think of R-squared as a measurement of evidence that the impressionability truly exists and is not just coincidence, whereas the beta itself measures the magnitude or extent of that impressionability.
Measuring the Overall Volatility of the Market
A variety of different market indexes are used to measure the performance and volatility of the stock market. Most notable among them are the Dow Jones Industrial Average and the S&P 500 index.