Volatility & Beta

Volatility vs Beta, a critical distinction which most investors and traders do not understand properly.

Never make the mistake of thinking that volatility and beta are the same.

After reading this post you will be able to understand the concepts well and you will get to know the difference between a low volatility and low beta stock.

Volatility vs Beta

Lets get straight to the point.

The beta of a stock is a measure of the correlation between the market and the stock. In other words, it measures the sensitivity of stock returns to market returns. The market is described by the performance of the NIFTY 50.

For example, the stock Vedanta has a beta of 1.45 so if the market (Nifty 50) goes up by 1% then on an average the stock would go up by 1.45% and if the market (Nifty 50) goes down 1% then the stock on average would go down 1.45%.

Volatility is marked as the standard deviation of stock returns over a one-year time frame. In simpler words, Volatility is a measure of much of a stock fluctuates.

Historical volatility which reflects how much the stock has bounced around in the past and Implied volatility is a projection derived from the options market of expected volatility in the future.

As a general rule you can say that stocks that frequently give big moves either up or down, are volatile.

So as you have seen the difference between volatility and beta is that volatility is absolute while the beta is relative.

Beta vs Volatility in terms of Risk

Now there are two kinds of risk namely Systematic Risk and Unsystematic Risk.

Systematic Risk is basically the intrinsic risk in the stock market (market risk) whereas Unsystematic Risk is the company-specific risk.

Beta is a measure of the systematic risk while Volatility is  the measure of the total risk (Systematic + Unsystematic).

Enough of theory, now lets get to an example to make things crystal clear.

Beta vs Volatility Example

Consider a stock X having a beta (0.68) and a volatility of (1.3) and then see another stock Y having a higher beta (1.5) and yet a lower volatility (1.1) and that might be confusing to you if you are just seeing beta and volatility just as measures of risk and not really understanding the difference between the two.

So (as discussed earlier) remember that volatility is the standard deviation of a stock’s return right so ultimately that’s a measure of total risk of the firm right so when you think about the volatility of X which is 1.3, thats the total risk of investing in stock X.

What the beta is measuring is the market risk of stock X so 0.68 is telling the percentage increase or change in stock X given a 1% change in the market. It is the systemic (market) risk of investing in stock X. This is the part of the risk that cannot be diversified away as this is stock X’s relationship to the overall market.

Volatility is considering not just the market risk that’s measured by beta but also firm-specific risk.

Stock Y has a higher beta and yet a lower volatility what this essentially means is the it has more market risk so if the market goes up, stock Y is going to magnify the market’s move and go up even further. The stock will go up 1.5% percent given a one percent increase in the market index and conversely the market goes down one percent, stock Y is going to go down 1.5%.

Low Volatility Stocks in Indian Stock Market 2018

Low Beta Stocks Indian Stock Market 2018

High Beta Stocks Indian Stock Market 2018

High Volatility Stocks in Indian Stock Market 2018

Conclusion: Low volatility vs Low beta

As investors if you are looking for a portfolio that falls lesser than the market, when the market is down and also gains lesser than the market when it is up then you should invest in low beta stocks.

On the other hand if you are looking for a portfolio in which despite of the direction in which the market goes, the variation is minimised then you should invest in low volatility stocks.

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