Therefore, Beta Coefficient depends on (1) the variability of the individual stock return; (2) the variability of the market return; and (3) the correlation between the return on the security and the return on the market.

The ratio of the Standard Deviation measures how variable the stock is in relation to the variability of the market. The wider this relationship becomes, the higher risk is associated with the individual stock relative to the market. The correlation coefficient in the formula indicates whether the greater variability is important.

For example, where the Standard Deviation of the individual stock is .02 and on the market .10 with a correlation coefficient of 1.0, Beta is 0.2 (.02/.10)(1)=0.2 indicating a strong positive relationship between the return on the market and the return on the stock.

When the stock. s return is less variable than the market as described above, the stock is less volatile than the market generally, and the stock has only a small amount of market risk appropriate for a conservative portfolio.

However, when the Standard Deviation is .18 with a Beta of 1.8, the stock is more volatile than the market and has a large amount of market risk appropriate for investors with a more aggressive risk reward perspective.

Generally, as long as there is a strong relationship between the return on the stock and the return on the market, i.e., and the correlation coefficient is not a small number, the Beta Coefficient has meaning in that if a stock has a beta of 1, the stock return should move in lock step with the market index as a whole.

Conversely, a Beta of less than 1 implies that the return on the stock would tend to fluctuate less than the market as whole.

This is a two edged sword. Based on a .7 Beta, you could expect the individual stock to react positively 7/10 of an increase as a result of a market rise of 10%. However, if the market declined 10%, you could expect the individual stock to decrease only 7/10 in relation to the market.

We all know that the market goes up and down routinely. Knowing the effect of an individual stock. s anticipated performance in relationship to the market in general offers the investor an opportunity to hedge his or her bets and construct a portfolio based on his or her objectives. With a fundamental understanding of Beta Coefficients, the investor can construct a portfolio using not only the typical diversification components of the old economy versus new economy, growth versus value, domestic versus international , but characterize the mix within each sector as it relates historically to the market overall. This perspective becomes a very useful tool to identify inherent risk. The numbers are available from any number of free services; and the next time you consider buying an individual stock or mutual fund, check the Beta to anticipate its performance relative to the market.