The beta coefficient is a statistical measure that can be used to compare different items.
The idea of using the beta coefficient is common among stock analysts trying to find those stocks that are moving differently to the main market average. This has a number of benefits, not least that stocks with higher beta coefficients offer a greater level of diversification than those with lower beta coefficients.
A stock with a low beta coefficient will be unlikely to outperform the overall market, whereas a stock with a high beta coefficient could move in a completely different direction. Some stocks with a high beta may even move in the opposite direction to the average, allowing them to survive market downturns.
In stocks, this beta can be measured with the following calculation:
Beta (x) = Slope of stock x / Slope of market average
In other words, if a stock increases in value by 14% while the market average increased by only 10%, the stock's beta would be 1.4. Generally, those markets with higher beta's can be said to offer better risk/reward.
Stock markets generally move higher over time, corresponding with economic growth and the act of buy and hold investing.
Conversely, forex markets fluctuate, where the simultaneous buying of one currency reflects the selling of another.
The upshot of this is that there is no point in calculating beta in forex by comparing one market to the slope of the market average.
A much better idea is to construct a market average of currencies, making sure to adjust them for their dollar values, then compare them by standard deviation.
By calculating beta in this way, it is possible to find the currencies that are trading with the highest volatility compared to the rest. In this way:
Beta (EURUSD) = StdDev (EURUSD) / StdDev (market average)
Of course, beta will not stay constant over time, and currencies with a high beta may not continue to be more volatile than the average in the future. This means that high beta currencies may not necessarily be the best ones to trade and it could be the case that the lowest betas might be the best.
Any strategy based on beta will therefore need to be tested to ensure that it works profitably. That is the nature of trading.
The idea of using the beta coefficient is common among stock analysts trying to find those stocks that are moving differently to the main market average. This has a number of benefits, not least that stocks with higher beta coefficients offer a greater level of diversification than those with lower beta coefficients.
A stock with a low beta coefficient will be unlikely to outperform the overall market, whereas a stock with a high beta coefficient could move in a completely different direction. Some stocks with a high beta may even move in the opposite direction to the average, allowing them to survive market downturns.
In stocks, this beta can be measured with the following calculation:
Beta (x) = Slope of stock x / Slope of market average
In other words, if a stock increases in value by 14% while the market average increased by only 10%, the stock's beta would be 1.4. Generally, those markets with higher beta's can be said to offer better risk/reward.
Using beta in forex
While beta is commonly used in stocks, it is rarely used in forex and for a very good reason. Simply, because forex markets are valued against one another, they do not possess any upward bias, like stock markets do.Stock markets generally move higher over time, corresponding with economic growth and the act of buy and hold investing.
Conversely, forex markets fluctuate, where the simultaneous buying of one currency reflects the selling of another.
The upshot of this is that there is no point in calculating beta in forex by comparing one market to the slope of the market average.
A much better idea is to construct a market average of currencies, making sure to adjust them for their dollar values, then compare them by standard deviation.
By calculating beta in this way, it is possible to find the currencies that are trading with the highest volatility compared to the rest. In this way:
Beta (EURUSD) = StdDev (EURUSD) / StdDev (market average)
Results
Calculating beta in this way, shows how currencies relate to each other in terms of volatility. Those currencies with a high beta are the most volatile and these are the best ones to trade since they offer the best risk/reward.Of course, beta will not stay constant over time, and currencies with a high beta may not continue to be more volatile than the average in the future. This means that high beta currencies may not necessarily be the best ones to trade and it could be the case that the lowest betas might be the best.
Any strategy based on beta will therefore need to be tested to ensure that it works profitably. That is the nature of trading.
Editors’ Picks
EUR/USD eases below 1.0900 amid cautious mood
EUR/USD has erased gains to trade on the back foot below 1.0900 early Tuesday. The pair treads water amid a cautious market mood, as traders weigh the US political updates and China slowdown worries. The US Dollar remains subdued, in the absence of top-tier economic data.
GBP/USD drops toward 1.2900 as US Dollar looks to stabilize
GBP/USD is dropping toward 1.2900, lacking firm direction in European trading on Tuesday. The US Dollar looks to stabilize after the early decline, weighing on the pair. Traders await mid-tier US housing data for fresh trading impetus.
Japanese Yen improves as US Dollar remains tepid due to rising odds of Fed rate cuts
The Japanese Yen extends gains as traders expect the BoJ to raise rates next week. Toshimitsu Motegi, a senior official in the ruling party, urged the BoJ to communicate its plan to normalize monetary policy. Media reports indicate that Vice President Kamala Harris has now surpassed 1,976 Democratic delegates, securing the party's presidential nomination.
Editors’ Picks
EUR/USD eases below 1.0900 amid cautious mood
EUR/USD has erased gains to trade on the back foot below 1.0900 early Tuesday. The pair treads water amid a cautious market mood, as traders weigh the US political updates and China slowdown worries. The US Dollar remains subdued, in the absence of top-tier economic data.
GBP/USD drops toward 1.2900 as US Dollar looks to stabilize
GBP/USD is dropping toward 1.2900, lacking firm direction in European trading on Tuesday. The US Dollar looks to stabilize after the early decline, weighing on the pair. Traders await mid-tier US housing data for fresh trading impetus.
Gold price struggles to gain ground amid mixed fundamental cues
A combination of factors drag the Gold price lower to nearly a one-week low on Tuesday. Bets that the Fed will cut rates in September could lend support and help limit losses.
Bitcoin price struggles around $67,000 as US Government transfers, Mt. Gox funds movement weigh
Bitcoin (BTC) struggles around the $67,000 mark and declines by 1.7% at the time of writing on Tuesday at around $66,350. Bitcoin spot ETFs saw significant inflows of $530.20 million on Monday.
Big tech rebound ahead of earnings, Oil slips
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Tesla and Google are due to report earnings today after the bell, and their results could shift the wind in either direction. Despite almost doubling its stock price between April and July, Tesla sees appetite for its cars and its market share under pressure.
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