Whether you are a trader or an investor: beta can be the measure of risk for you!

Fri, Sep 28, 2018 1:45 PM on Financial Analysis, Recommended, Stock Market,

NEPSE; the only local bourse of the country finally took an uptrend after months of wait. Investors and traders have come to the trading floor in order to benefit from the recently rising market. This time is crucial for investment. One half of the investors believe the market has taken an upward trend whereas the next half attribute the increase to expectation of dividends. In such cases, investors and traders can undertake investment/trading decision based on beta of a stock.

“Beta” calculation has further been simplified with SS Pro provided that the software calculates the updated beta of each and every company on a daily basis.

“Beta” is simply the representation of how risky is the share you are holding. Beta evaluates the risk of the shares as it bases its calculation on volatility of a stock with respect to the market. As we can see, in the current scenario, most of the highest turnover and top gainers position have been occupied by stocks from banking sectors. It is of no doubt that the investors are interested in stocks from banking sector particularly because of the price hike and dividend return these banks will offer in the near future. In such cases, investing can be intimidating so, beta calculation can help investors to play safe whereas traders to play fast.

The beta of market i.e. NEPSE is 1 so, individual stock’s beta are positioned in such a way that represents how it deviates from the market.

More volatile stocks ---------Beta value > 1

Less volatile stocks/ Lack of synchronization with market------Beta value < 1

A beta value equals to 1 represents that the stock of a company and the market moves together. However, a beta less than 1 represents that the stock is comparatively less volatile than the market. It might also denote that the market and the stock are not moving in the same direction. Furthermore, a beta more than 1 represents theoretically the stock is more volatile than the market.

If we consider two different commercial banks of the country:

1) NMB Bank Limited 2)NIC Asia Bank Limited

NMB Bank Limited has a beta around 1.47. This shows that NMB’s stock is around 47% more volatile than the market.

However, if we consider the beta of NICA, it stands around 0.66. Whenever the value of beta is less than 1, then only one reason might not suffice the value. First reason suggests the stock might be comparatively less volatile than the market. Second reason might suggest the stock and market are not synchronized. There are further two more cases when market and stock are not synchronized.

  • One of the cases of lack of synchronization between market and the stock can be: market moves up by 5% whereas stock moves up by a relatively lower percentage i.e. 1%.
  • Second case can be when market goes down by 5% whereas stock goes down by only 10%. In case of NIC Asia’s stock, although market has gone slightly upward, the stock\s movement is very high. Similarly, although market has fallen down at a greater proportionate, stock’s downfall is comparatively less. Screenshot of the same is provided by SS Pro (software has recently included saving feature in technical analysis):

NEPSE= Green

NIC Asia =Red

In some cases, beta value can also be negative. In international markets, when beta value is negative, investors/traders can hedge against market risk. The concept of hedging is yet to be implemented in Nepal.

How to calculate Beta?

The calculation of beta of NMB Bank Limited can be referred to from the following table:

The time period has been considered for the last 21 trading days for the calculation of monthly beta of NMB Bank Limited.

The daily return of index and stock closing price has been calculated using the formula (Yesterday’s closing price/Today’s closing price -1).

Further beta has been calculated as (Covariance of (return of NMB, return of NEPSE)/Variance of (return of NEPSE).

Why a trader or an investor should consider beta value?

A trader or an investor should consider several factors including beta while making a decision in secondary market. As a trader, it is important to consider beta because it prevents you from investing in stocks with less volatility. For instance, a trader’s objective is to maximize short term profit so, the more volatile a stock, more the profit/loss. Here, beta can be a weapon to evaluate volatility. Similarly, for investors who want to play safe and are optimistic for a bullish market, a beta near one will always be preferable as there will be lower possibility of losing more as compared to stocks with higher beta.

This does not imply that investors and traders should blindly follow beta as the only principle for investment. Beta has its own limitations. For instance, it considers only the historical price. Furthermore, beta is not an absolute value so; decisions cannot be made only considering this particular tool.

However, investment/trading can get simpler when it is made bringing one’s risk appetite and value of beta together.

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