Betting on the Beta

Beta is a measure of a stock’s risk in relation to the market or to an alternative benchmark.

The stock market (represented by an index such as the Dow or the S&P 500), is assigned a beta of 1.0. By comparison, a stock which has a beta of 0.5 will tend to participate in the broad market moves, but only half as much as the overall market. On the other hand, a stock with a beta of 2.0 will tend to benefit (or suffer) from broader market moves twice as much as the market overall.

The fellow who developed this theory was William Sharpe, although the moniker “beta” was applied some time later (and for reasons I’ll never know). Most every stock has a beta, and many financial Web sites include this information in their discussions of individual stocks. Yahoo, for example, posts this data, and a good deal of other financial froufrou for every stock under its “Key Statistics” listing.

Using the Beta to Your Advantage

Now let’s take a look at a specific stock. When this article was written, Best Buy (BBY) was showing a beta of 1.44. Depending on your trading strategy, this number could be useful, since it suggests that when the market indexes are up sharply, BBY may often show a gain that’s 1.55 times greater than the shift in the market.

If your trading strategy is to ride stocks up during strong markets, then BBY might be a good pick since it rises to a greater degree than the market as a whole. If you’re particularly daring, you might go long with Dynamic Materials (BOOM), since it’s beta was 8.14.

But the point is simple:  Knowing a stock’s beta should forewarn you to (1) Get out fast in a declining market; and (2) clamor aboard as quickly as possible in an upwardly moving market. Know the beta, and use it to your advantage.

Beta numbers are readily available in a number of different financial Web sites. I’d recommend that you look first to Yahoo. You’ll find the beta number for BBY here.