Beta Neutral

Many funds use academic theory and use “Beta” as the neutral point when deciding how to make their portfolios market neutral. Beta is is the number used to measure implied risk, Hedge fund managers use it to rank the risk of  an asset. The formula for beta is slightly confusing, it compares the standard deviation of stock to the standard deviation of the market. Usually the performance of an index like the S&P 500. Beta neutral portfolios are made up of stocks that are weighted average beta of 0, this means the portfolio has no market exposure. This is a typical hedge fund strategy, generating a profit without being exposed to market risk.

Modern Portfolio Theory (MPT) shows the market has a beta of 1 and stocks linked with the market have a beta of 1. A security that is negatively correlated to the market has a beta of – 1 and a security that has no correlation with the market has a beta of o.

If you think the markets will rise in value you could buy high-beta stock to increase your yield. However if you want to reduce your exposure you could buy stocks with betas of less than 1. If you think the markets will reduce in value you should find stocks with a negative beta because they should increase in value as the markets go down.  You can create negative beta by shorting a stock with a high positive beta.

My advise for what its worth is, if you’re a retail trader ignore beta instead protect your capital with protective stop loss orders and identify stocks that are increasing in volatility. Retail traders aren’t burdened with the responsibility of managing a clients capital, this allows them to make quick decisions regarding their portfolio and move quickly in and out of positions, moving to where the action is!