fbpx

How to Calculate Beta

Benzinga Money is a reader-supported publication. We may earn a commission when you click on links in this article. Learn more.

Jump straight to Webull! Get real-time market data, analysis tools and $0 commissions.

Beta is the 2nd letter in the Greek alphabet, and the financial world uses it to refer to the sensitivity of an asset’s price compared to a specific index or benchmark. Beta is also used as a measure of an asset’s risk relative to that benchmark. The beta of a stock tells an investor how much a stock moves compared to the general stock market it trades in. Read on to find out more about this very important asset risk metric.

Beta Calculation

The beta can readily be computed for a stock or portfolio in a spreadsheet like Excel using opening and closing price data for each stock and the relevant stock market index. Three methods for calculating the beta on an individual stock are described below.

Variance/Covariance Method

Calculating beta using the covariance/variance formula is probably the most common method of calculating the beta of a stock. This formula takes the covariance of the return of the market and the return of the asset and then divides that by the market return’s variance over a given time frame. 

To calculate beta for a stock using this method, you first need to understand the following terms:

  • Variance (σ2): The spread between numbers in a specific data set. In finance, the variance is commonly used to calculate how each asset in a portfolio performs in relation to the other assets in the portfolio. It can also be used to determine the amount the market moves in relation to its mean.
  • Covariance: A measure used in finance to determine the similarity and degree of the directional relationship between the returns on 2 assets. If 2 stocks move in the same direction, then they have a positive covariance of an amount proportional to the degree they do so. If they move in opposite directions, the covariance is negative in an amount related to the degree that they diverge.

Furthermore, given that: 

Return = closing price – opening price/opening price

The formula for the beta calculation could then be written: 

Beta = Covariance of market and asset returns / Variance of the market’s returns

or

Where:

?i= beta of asset i

r= average expected return on asset i

rm = average expected rate of return on the general market

The Correlation Method 

This method of calculating beta involves dividing the standard deviation of an asset’s returns by the standard deviation of the market’s returns and then multiplying the result by the correlation of the asset’s and the market’s returns: 

?i = (σi / σm)*Correlation (ri, rm

Where: 

?i= beta of asset i

r= average expected return on asset i

rm = average expected rate of return on the general market

σi = standard deviation of the asset’s returns 

σm= standard deviation of the market’s returns

The Slope Method 

Beta can also be calculated for an asset using the SLOPE function in Microsoft Excel. This function computes the slope of a regression line based on 2 sets of data points. To compute the beta, these data point sets should correspond to the set of percent changes in a market index and the set of percent changes of the specific asset’s price observed over the same time period. 

You would enter this formula into a cell to compute beta from market and stock returns: 

beta = SLOPE (Market returns range, Stock returns range)

Where:

Market returns range = Rows and columns of 1st market return and last market return separated by a colon (:), as in A1:A500 where column A contains 500 daily returns of the market. 

Stock returns range = Rows and columns of 1st stock return and last stock return separated by a colon (:), as in B1:B500 where column B contains 500 daily returns of the stock.

As before, returns are calculated for each period for the stock and the market by subtracting the open from the close and then dividing by the open.

Calculating Beta Example

To calculate the beta of Apple Inc. (NASDAQ: AAPL) as a specific example using the covariance/variance method, you would take the covariance of the expected return on AAPL stock to the average expected return on the S&P 500 index and then divide that number by the variance in the overall S&P 500 market’s average expected return. 

Let’s say the covariance of the S&P 500’s return to AAPL’s returns is 0.032, which is then divided by the average market return’s variance of 0.0235 to give us a beta of 1.36. The formula would look like this:

AAPL beta = 0.032 / 0.0235 = 1.36

In practice, a beta of 1.36 means that the returns involved in holding Apple stock are about 36% more volatile than those derived from the S&P 500 index. Holding Apple stock therefore presents a greater degree of investment risk than holding a portfolio of stocks conforming to the overall S&P 500 market. 

In general, a stock that moves in tandem with the market would have a beta of 1.0. If the stock moves less than the general market, the beta would be below 1.0, while a stock that moves more than the general market would have a beta of more than 1.0.

Calculate Beta of a Portfolio

As any seasoned investor and portfolio manager know, an important consideration when building a portfolio consists of the level of diversification. Diversifying stocks in your portfolio lowers investment risk — owning stocks in a wide range of companies and industries tends to reduce the overall volatility of the portfolio. 

Accordingly, when you own stocks in a broad number of companies, your exposure to market events generally decreases because some stocks remain unaffected or are affected either positively or negatively by an event. This is one good reason that portfolio managers give importance to the beta of a portfolio. 

To calculate the beta of a portfolio, follow the steps outlined below:

  1. Calculate the value of each stock you own in your portfolio by listing the number of shares you have multiplied by the current share price.
  2. After you’ve determined the value of each stock holding in the portfolio, calculate what proportion or share each stock represents in the portfolio. 
  3. Multiply those proportions by the beta of each stock. For example, if Apple Inc. makes up 0.30 of the portfolio and has a beta of 1.36, then its weighted beta in the portfolio would be 1.36 x 0.30 = 0.408. 
  4. Add up the weighted beta numbers of each stock. The sum of the weighted betas of all the stocks in the portfolio will give you the portfolio’s overall beta. 
StockValuePortfolio shareStock betaWeighted beta
Apple Inc. $40,0000.301.360.408
Tesla Motors$25,0000.201.950.390
General Electric$20,0000.181.230.221
Pfizer Inc. $50,0000.320.5820.186
Overall1.20

In the table above, the value of the stock in the portfolio and the proportion or share of the portfolio of each stock can be seen in the 1st 2 columns. The sum of the weighted betas in the furthest column to the right gives you the overall beta of the portfolio.  

Best Online Stock Brokers

Most online brokers provide excellent stock research resources, but some brokers may be more suited for your needs than others. Below we have compiled a list of some of the best online stock brokers for building a portfolio. Make sure you have a good idea of what you need in a broker before funding an account with them. 

Best For
Advanced traders
Overall Rating
Get started securely through Moomoo’s website
Best For
Advanced traders
N/A
1 Minute Review

Moomoo is a commission-free mobile trading app available on Apple, Google and Windows devices. A subsidiary of Futu Holdings Ltd., it’s backed by venture capital affiliates of Matrix, Sequoia, and Tencent (NASDAQ: FUTU). Securities offered by Futu Inc., regulated by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA).

Moomoo is another great alternative for Robinhood. This is an outstanding trading platform if you want to dive deep into smart trading. It offers impressive trading tools and opportunities for both new and advanced traders, including advanced charting, pre and post-market trading, international trading, research and analysis tools, and most popular of all, free Level 2 quotes.

Get started right away by downloading Moomoo to your phone, tablet or another mobile device.

Best For
  • Cost-conscious traders
  • Novice traders
  • Active/Advanced traders
Pros
  • Free Level 2 market data for all users who open an account
  • Commission-free trading in over 5,000 different stocks and ETFs
  • Over 8,000 different stocks that can be sold short
  • $0 contract fee for trading options, no commission either
  • Strong market data and analysis tools with over 50 technical indicators
  • Access trading and quotes in pre-market (4 a.m. to 9:30 a.m. ET) and post-market hours (4 p.m. to 8 p.m. ET)
  • No minimum deposit to open an account.
  • Active trading community with more than 100,000 app users
Cons
  • No phone or chat support
Best For
Options Trading
Overall Rating
Get started securely through TD Ameritrade’s website
Best For
Options Trading
N/A
1 Minute Review

This publicly listed discount broker, which is in existence for over four decades, is service-intensive, offering intuitive and powerful investment tools. Especially, with equity investing, a flat fee is charged, with the firm claiming that it charges no trade minimum, no data fees, and no platform fees. Though it is pricier than many other discount brokers, what tilts the scales in its favor is its well-rounded service offerings and the quality and value it offers its clients.

Best For
  • Novice investors
  • Retirement savers
  • Day traders
Pros
  • World-class trading platforms
  • Detailed research reports and Education Center
  • Assets ranging from stocks and ETFs to derivatives like futures and options
Cons
  • Thinkorswim can be overwhelming to inexperienced traders
  • Derivatives trading more costly than some competitors
  • Expensive margin rates
Best For
Options Education
Overall Rating
Get started securely through Tastyworks’s website
Best For
Options Education
N/A
1 Minute Review

Tastyworks is a sophisticated options and futures broker aimed toward experienced traders. The platform was designed by the founders of thinkorswim with functionality and precision for complicated options trades and strategies. Tastyworks offers stocks and ETFs to trade too, but the main focus is options. 

Options on tastyworks are only charged a 1-way, $1 commission —  far cheaper than almost all competitors. Commissions on futures and micro futures are also affordable, and there’s no minimum required to open a cash account. It’s $2,000 if you want to use margin.

Best For
  • Options traders
  • Futures traders
  • Advanced traders
Pros
  • Powerful platform inspired by thinkorswim
  • Multiple order types and strategies
  • Cheap options commissions
Cons
  • Advanced platform could intimidate new traders
  • No demo or paper trading
Best For
Intermediate Traders and Investors
Overall Rating
Get started securely through Webull’s website
Best For
Intermediate Traders and Investors
N/A
1 Minute Review

Webull, founded in 2017, is a mobile app-based brokerage that features commission-free stock and exchange-traded fund (ETF) trading. It’s regulated by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA).

Webull offers active traders technical indicators, economic calendars, ratings from research agencies, margin trading and short-selling. Webull’s trading platform is designed for intermediate and experienced traders, although beginning traders can also benefit.

Webull is widely considered one of the best Robinhood alternatives.

Best For
  • Active traders
  • Intermediate traders
  • Advanced traders
Pros
  • Commission-free trading in over 5,000 different stocks and ETFs
  • No account maintenance fees or software platform fees
  • No charges to open and maintain an account
  • Leverage of 4:1 on margin trades made the same day and leverage of 2:1 on trades held overnight
  • Intuitive trading platform with technical and fundamental analysis tools
Cons
  • Does not support trading in mutual funds, bonds or OTC stocks

Using Beta to Evaluate Risk

If you’ve been trading or investing in recent times, then you probably already understand how vital assessing the risk involved in a stock or market is before taking a position. By diversifying your portfolio, you’ll probably reduce the risk of the portfolio against general market moves. 

Since beta is based on price and determined relative to the market, however, it may not be the best assessment of risk for some stocks. To accurately determine the risk of a stock, take into account the company’s fundamentals, its earnings and business prospects and the future market for its products or services. Other factors that can indicate risk include the firm’s level of debt, the cost of servicing that debt and the value of assets. 

Finally, remember that if the overall volatility of the market increases, as it has in 2020, then a stock with a beta of 1 would also experience the same higher volatility levels. While the beta of a stock can be useful as a risk assessment, it is relative and so can change with market volatility. Make sure you research your investments thoroughly and have a suitable risk appetite before committing your funds to a particular stock.   

Benzinga's #1 Breakout Stock Every Month

Looking for stocks that are about to breakout for gains of 10%, 15%, even 20% potentially or more? The only problem is finding these stocks takes hours per day. Fortunately, Benzinga's Breakout Opportunity Newsletter that could potentially break out each and every month. You can today with this special offer:

Click here to get our #1 breakout stock every month.