Use Beta Measurement to Determine the Volatility of a Stock for Investment
To be a successful investor, you need to understand the volatility of the particular stock you invest in. In stock market parlance, this volatility is also called the beta of a stock. Beta is a quantitative measure of the volatility of a given stock (mutual funds and portfolios, too) relative to the overall market, usually the S&P 500 index.
Beta specifically measures the performance movement of the stock as the S&P moves 1 percent up or down. A beta measurement above 1 is more volatile than the overall market, whereas a beta below 1 is less volatile. Some stocks are relatively stable in terms of price movements; others jump around.
Because beta measures how volatile or unstable the stock’s price is, it tends to be uttered in the same breath as risk — more volatility indicates more risk. Similarly, less volatility tends to mean less risk.
The beta is useful to know when it comes to stop-loss orders because it gives you a general idea of the stock’s trading range. If a stock is currently priced at $50 and it typically trades in the $48 to $52 range, then a trailing stop at $49 doesn’t make sense. Your stock would probably be sold the same day you initiated the stop-loss order.
If your stock is a volatile growth stock that may swing up and down by 10 percent, you should more logically set your stop-loss at 15 percent below that day’s price.
The stock of a large cap company in a mature industry tends to have a low beta — one close to the overall market. Small and mid cap stocks in new or emerging industries tend to have greater volatility in their day-to-day price fluctuations; hence, they tend to have a high beta.