What is High Beta Stocks?

What is High Beta Stocks and why they are so important?

You must have heard the name “High Beta Stocks” often in media or with your brokers. But do you know that, what it means by High Beta Stocks? Well, to understand this, you have to first understand what it means by “Beta” of any stock?

What it means by “Beta”?

According to Investopedia,

“A measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Beta is used in the capital asset pricing model (CAPM), a model that calculates the expected return of an asset based on its beta and expected market returns.
Also known as "beta coefficient".

Explanation of Beta in Layman’s language -

A beta of 1 indicates that the security's price will move with the market. A beta of less than 1 means that the security will be less volatile than the market. A beta of greater than 1 indicates that the security's price will be more volatile than the market. For example, if a stock's beta is 1.2, it's theoretically 20% more volatile than the market.

The Beta of Index mutual funds is 1. Because the portfolio of Index fund is the mirror image of the index and the beta of the various stock indices is considered as 1. So it means that, the portfolio return of index funds will closely track the performance of the market.

Now, suppose if beta of any stock is 0.80 than it means that the stock is 20% less volatile than the market. So if the market will be down by 10%, that stock will be down by just 8% (20% less than the market) and if the market will go up by 10% than the stock will give you 8% return (20% less than the market).

When the market is at all time down, high beta stocks are in demand. Because if you invest in high beta stocks at the down market, you will outperform than the market when the market will be up. And that’s why sophisticated investors look for high beta stocks in the down market.