Trading high beta stocks are stocks that move in the market with a greater degree of volatility (wider price movements) compared to stocks that move in the market with much smaller price movements. Trading a stock of a high-tech company versus trading one from an utility company would be such an example.
There are many traders who prefer trading high beta stocks due to the profit potential they can offer in a shorter amount of time.
The beta value (volatility) of a stock is a relative value. In order to measure the significance of a relative beta value, it needs to be compared to a benchmark that represents volatility in the stock market taken as a whole – which is defined to have a beta value of 1.
The benchmark that is customarily used to represent volatility in the stock market taken as a whole is the S&P 500 index (or some other representative index if your stock is specialized or unique in nature). The S&P 500 index consists of a basket of 500 stocks that makes for a broad and diversified index which is why it’s typically used to represent total market volatility with a beta value of 1.
Beta Defined
Beta is calculated from using a mathematical formula that measures the statistical deviation (theoretical level of risk) of a stock’s price relative to the risk assessed in the overall market.
Gauging a stock’s beta value (volatility) relative to that of the overall market can be expressed as follows:
- Greater than 1 is more volatile than the level of volatility assessed in the overall market
- Equal to 1 is about the same level of volatility assessed in the overall market
- Less than 1 is less volatile than the level of volatility assessed in the overall market
Example: if a stock has a beta of 1.30, it will (in theory) fluctuate 30% more in price (either rising or falling) compared to the fluctuation of prices in the overall broader market where the beta value is considered to be 1.
By knowing the beta (risk) of a stock, you can have a better idea (theoretically) of how fast that stock will rise or fall in price in relation to the price movements in the overall broader market.
Another way to gauge the beta of a high beta stock is by overlapping the price history of such a stock to that of the S&P 500 index on a line chart. This will allow you to visually see the relative price volatility behavior that each one has when compared against each other. In rising markets, the price of a high beta stock should be above the price of the S&P 500 index, while in falling markets the price of a high beta stock should be below the price of the S&P 500 index.
Finding High Beta Stocks
There are different ways to find high beta stocks such as:
- Recent new IPO’s (initial public offerings) that have promising yet unproven track records
- Small cap companies that are rapidly growing in revenues and earnings
- Analyzing the size of the length between the highs and lows of price movements for a certain trading session on a chart. The longer the length, the greater the volatility
- Using stock screeners to scan for high beta stocks by inputting a beta value greater than 1
Industries With High Beta Stocks
Industries that have high beta stocks include such industries as high-tech, bio-tech and energy. Stocks within these industries usually have larger price movements (higher volatility) than that of the broader overall market.
Gauging Volatility In The Market With Indexes
To help gauge the level of volatility in the stock market, the following indexes were created to do just that:
- The CBOE Volatility Index (VIX)
- The S&P 500 High Beta Index (SPHB)
Last Thoughts About Trading High Beta Stocks
High beta stocks offer the potential for greater rewards (profits) in a faster amount of time due to the greater price movements they offer. However, they also carry more risk as a result. In trading, risk and reward goes hand-in-hand.
