Deciding whats stocks to invest into and how to do it is never a straightforward process. eToro offers hundreds of assets as well as a great variety of statistics, risk metrics and technical analysis tools, which may be quite overwhelming to navigate in. Let’s have a look at one of the most popular concepts in finance, – beta of a company, what it is and how you can use it in your trading process on eToro.
(NOTE: Before we continue, we have to give a disclaimer that the trading products offered by the companies listed on this website carry a high level of risk and can result in the loss of all your funds. CFDs are complicated instruments that are never guaranteed to provide you supplemental earnings. In fact, Around 68% of all retail investors experienced a loss while trading CFDs. Make sure to keep this in mind before attempting to use the eToro platform yourself. All the information found on this website is not official trading advice and all practices shown are referenced for the use of the Demo account only.)
What is a company’s beta?
Beta measures how volatile a security is as compared to the market as a whole, how responsive or sensitive price of an asset is to market variations. In simple terms, it is a numerical indication of how much of a company’s returns can be predicted by the market. But what is the broad market itself? Usually the S&P500 index is used as a proxy as it is composed of 500 largest US companies. Beta is a widely used risk measure (measure of systematic or market risk, to be precise) and is the center piece of the modern portfolio theory and the Capital Pricing Asset Model (CAPM). The beta of a market portfolio is then 1 of course, as the market is as volatile as it is itself. Beta of an asset greater than 1 means the security is more volatile than the market and beta of below 1 indicates the security is less volatile than the market. It is calculated as the coefficient of a regression of returns of an asset (usually past historical returns) on returns of a market, i.e. the S&P500 index.
How to interpret beta?
Let’s look at the example of the company below, which has a beta of about 1.42. You can conveniently find beta of each company on eToro under the ‘Stats’ section, like shown on the image. What does this value actually mean? If the market i.e. S&P500, makes a return of 10%, this stock which has a beta of 1.42 makes a gain of 10% x 1.42 = 14.2% as compared to the market. The opposite also applies, so if the market drops in value by 10% the returns on this stock drop proportionally by 14.2%.
How does beta affect your investment on eToro?
Beta of a company may be quite important for your risk management process on the eToro platform. As you hopefully realized, the impact of beta on the assets in your investment portfolio on eToro depends on the direction of the market. If the market is moving upwards (i.e. bullish) and your beta is above 1, the returns on your assets would be greater than market returns in proportion to the beta and you might take advantage of this opportunity by taking a long position in the asset. On the other hand, if the market is going down (bearish), shorting an asset may be an option if the asset is likely to fall in price by more than the actual market. It is important however to monitor these positions in case the market changes direction and adjust accordingly.
Stocks that have a higher beta (also known as ‘high beta stocks’) are considered to be riskier and are therefore thought to require a higher return for this greater associated risk and vice versa, low beta stocks that have lower volatility deliver lower returns. Beta is considered to be a good indication of the risk of a company. Beta however has its own limitations of course. It is often considered to be more indicative of short-term risk rather than long-term. It is also based solely on company and market returns and does not consider company fundamentals; it may therefore be of a limited use when it comes to using beta for actual stock selection. Beta estimation of market returns bases its predictions solely on one factor, which is the market, without considering other factors that might affect them. Finally, because it is based on past information it doesn’t actually incorporate new information, and as you know past performance is not necessarily indicative of future results.
Hopefully now you have a better understanding of what a company’s beta is and how you can employ it in your trading process on eToro. Remember that any trading involves capital loss risk and enjoy using the platform! Best of luck.
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