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; 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.
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