High Beta vs. Low Beta

Beta is the volatility measure of a portfolio compared to the entire market.

The market has a beta of 1, so we look at stocks relative to that number. A beta greater than 1 would mean that the stock is riskier (but that also means there are higher rewards) and likewise, a beta less than 1 would mean the stock is more low risk, low return.

For example, if a stock A had a beta of 1.75, that means it moves 75% more than the market. So if the SP 500 moved 1%, we could expect to see A move 1.75%.

With many investors being risk averse due to recent market circumstances, people are starting to lean towards lower beta portfolios.

For example, say a trader was considering trading in APA, a crude oil underlying. However, it has a beta of 1.75, which makes it a rather risky trade relative to the overall market. So how do we get around that?

Let’s look at XOM, a stock with a beta of 1 and a 0.70 correlation to APA. It measures the crude oil market, just as APA does, but has a lower systematic risk.

However, XOM does have a larger market capitalization and is more expensive. But this isn’t always a bad thing.

XOM isn’t as volatile because of the lower beta, and has lower bankruptcy risk. This is super important considering the relative underlying craziness of the market and the entire crude oil industry.

But for some trades, it is better to have the higher risk-higher reward. For me, I like to play it safe and focus more on high probability of success. I believe that a lot of high probability trades played out over time will serve better than one big risk trade. But to each their own!

Just keep trading!

Disclaimer: These views are not investment advice, and should not be interpreted as such. These views are my own, and do not represent my employer. Trading has risk. Big risk. Make sure that you can balance your risk/reward, and trade small, and trade often.

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