Let’s add it to our list of strange financial words that only the pros know about. High beta stocks is one of those investing phrases that you will hear and read but you may have no idea what it means. Know this: It’s very important and quite an easy term to understand.
My family is a group of differing personality. From the same two parents come some of the most level headed people and some of the most emotional people I know. I love all of them for their differing personalities but it’s interesting to see how they react to different situations.
Think about your family or think about some of your friends. Do some seem to be rock-solid in their personality and others seems to be what we call moody? If you understand this concept, you understand what beta means and you you’re one step closer to understanding high beta stocks.
When you look at the fundamentals for any stock, you will see a line for beta. Beta simply measures the volatility of the stock. If the beta is 1.0, that means it moves just as the S&P 500 moves, generally speaking. If the S&P moves 1% up, down, or both, that is generally the way the stock will move as well.
Everything having to do with beta stems from that 1.0 rating. If a stock has a beta below 1.0, you can expect that the stock will not move up and down as much as the S&P. While the S&P may have a bad couple of days moving down 3%, a low beta stock will not. (again, we’re talking about averages) A stock with a beta of .75 may only move 2% or even less.
In contrast, high beta stocks are more volatile or moody. Looking at that same 3% dip in the S&P, you shouldn’t be surprised to see that high beta stock move 5% over the same amount of time.
Keep in mind that volatility doesn’t measure how well a stock correlates with the S&P. It measures the rate of change. The higher the beta, the more violent or large the swings in price may be. As I write this article, AIG, the government controlled bank, has moved up more than 250% in one month while the market is only up a small amount. That’s a seriously high beta stock. In fact, AIG’s current beta is listed at 4.07! 4 times that of the S&P. That’s huge!
In this case, at the time of this article, AIG has gone up huge but any investor knows one important thing: A beta that high is like playing with fire. AIG may plummet in value.
Think of it this way: If you’re looking to make fast money, you need high beta stocks. The problem is, of course, you may lose money fast as well. If you’re looking for a safe, long term investment that doesn’t need watched all day, you want a low beta stock.
Here’s the final point. You have heard of diversification. You need to think of diversifying with high and low beta stocks as well. Low beta stocks, healthcare stocks are one example, will protect your assets much better if the stock market starts to sell off. They won’t, however, make you large amounts of money in the short term, even if the market rallies. If you sense the market getting on an upside run, find some high beta stocks. Then, when the market reaches it’s top, take your profit and get in to low beta names until it decides to go back up.
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Stock trading advice is all over the net and much of it is worth a read but you should never make choices based solely on this advice. Make your own choices. Remember, it’s your money.