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Understanding the Beta

Beta (or beta coefficient) is a means of measuring the volatility of a security or portfolio of securities in comparison with the market as a whole. This is very important in understanding and managing investment risk. Beta is the result of a fairly complex analysis, but the result is that a beta of 1 indicates that the security's price will move with the market. A beta greater than 1 indicates that the security's price will be more volatile than the market, and a beta less than 1 means that it will be less volatile than the market.

By way of an example, utilities stocks and bank stocks may have a beta of less than 1, whereas high-tech Nasdaq-based stocks typically have a beta greater than 1 because they offer the possibility of a higher rate of return but are also more risky. You can think of beta as the tendency of a security's returns to respond to swings in the market. For example, if a stock's beta is 1.2, it's theoretically 20 percent more volatile than the market. It stands to reason that if you expect the markets to perform well, you'll get the greatest gain from securities with a high beta, and if you expect the markets to do poorly, you'll have less risk with lower beta stocks.


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