Systematic risk, or total market risk, is price volatility that affects stꦺocks across many industr🍌ies, sectors, and asset classes. Risks that affect the overall market are by their nature difficult to predict and hedge against.

Diversification cannot help an investor to smooth out systematic risk, given that it affects all or most industries. For example, the Great Recession was a form of systematic risk. The economic downturn aff♛ected the market as a whole and brought down the prices ⭕of most individual stocks.

Investors can still try to minimize the level of exposure to systematic risk by looking at a stock's beta, or its correlation of price movements to the broader market as a whole.

Beta and Systematic Risk

Beta is a measure of a stock's volatility in relation to the market. It essen🌄tially measures the relative risk exposure of holding a particular stock or sector in relation to the market.

🃏The beta of individual stocks is often listed as a key statistic in the summary section of stock quotations. However, you can calculat🌊e beta on your own, whether for a single stock or an entire portfolio of stocks.

Beta effectively describes the activity of a stock's returns as it responds to swings in the market. A security's beta is computed by dividing the product of the 澳洲幸运5官方开奖结果体彩网:covariance of the security's returns and the market's returns by the variance of the market's returns over a specified ꦇperiod, using this form𒐪ula:

$\begin{aligned} &\text{Beta coefficient}(\beta) = \frac{\text{Covariance}(R_e, R_m)}{\text{Variance}(R_m)} \\ &\textbf{where:}\\ &R_e=\text{the return on an individual stock}\\ &R_m=\text{the return on the overall market}\\ &\text{Covariance}=\text{how changes in a stock's returns are} \\ &\text{related to changes in the market's returns}\\ &\text{Variance}=\text{how far the market's data points spread} \\ &\text{out from their average value} \\ \end{aligned}$​Beta coefficient(β)=Variance(Rm​)Covariance(Re​,Rm​)​where:Re​=the ওreturn on an individual stockRm​=the return on&nb๊sp;the overall marketCovariance=how changes in a&nbౠsp;stock’s🎶 returns arerelated&nbsღp;to changes in ꧋;the market’s returnsVariance=how&🔥nbsp;far the▨ market’s data points spreadout from their average value​

Note that beta can also be calculated by running a linear regression on a stock's returns compared to the market using the 澳洲幸运5官方开奖结果体彩网:capital asset pricing model (CAPM).

In fact, this is why this measure is called the beta coefficie꧒nt, since statisticians and econometricians label the coefficients of explꩵanatory variables in regression models as the Greek letter ß. The formula for CAPM is:

What Does Beta Tell You?

Once you've calculated the beta of a stock, it can then be used to tell you the relative correspondence of price movements in that stock, given the price movements in the broader market as a whole.

• A beta of 0 indicates that the portfolio is uncorrelated with the market. In other words, the stock or stocks' movements are independent of the broader market.
• A negative beta (i.e., less than 0) indicates that it moves in the opposite direction of the market and therefore have a 澳洲幸运5官方开奖结果体彩网:negative correlation with the market.
• A beta between 0 and 1 signifies that it moves in the same direction as the market, but with less volatility—that is, smaller percentage changes—than the market as a whole.
• A beta of 1 indicates that the portfolio will move in the same direction and have the same volatility. It is sensitive to systematic risk. Note that the S&P 500 index is often used as the benchmark for the broader stock market and the index has a beta of 1.0.
• A beta greater than 1 indicates that the portfolio will move in the same direction as the market, and with a higher magnitude than the market. Stocks with betas above 1.0 have a very high degree of systematic risk.

Low-Beta ETFs

Not surprisingly, there are exchange-traded funds that concentrate on low-beta choices. Low-beta choices include 澳洲幸运5官方开奖结果体彩网:covered call funds, low-beta sector focus, and bond funds. Bond funds include the iShares 1-5 Year Investment Grade Corporate Bond ETF and Wisdom Tree Floating Rate Treasury Fund.

Other funds concentrate on stocks in sectors that intrin𓆉sically have low betas, such as Utilities Select Sector SPDR Fund and Global X NASDAQ 100 Covered Call ETF.

Example

Assume that the beta of an investor's portfolio is 2.0 in relation to a broad 澳洲幸运5官方开奖结果体彩网:market index, such as the S&P 500. If the market increases by 2%, then t☂he portfolio will generally increase by 4%. If the market decreases by 2%, the portfolio generally decreases by 4%.

This portfolio is therefore sensitive to systematic risk. The risk can be reduced by hedging. This can be achieved by obtaining ꧋other stocks that have negative or low betas, or by using derivatives to limit downside losses.

The Bottom Line

Beta is a useful number to look at when you want to see whether a stock is likely to move up or down with the market or move in the oppoꦬsite direction of the market.

Stocks that have a low beta, such as consumer staples, are often used to hedge a portfolio of higher-beta stocks. These low-beta stocks are relatively unaffected by the market's gyrations or even benefit in times when the economy is poor.