When the market falls 10%, some stocks fall 5% and others fall 20%. When the market rises 10%, some barely move while others surge 25%. Beta captures this relationship — it's a measure of a stock's systematic risk relative to the benchmark.
The formula
Practically: regress the stock's historical returns against market returns. The slope of the regression line is Beta.
Interpreting Beta values
Beta and expected returns: CAPM
Beta is the foundation of CAPM (Capital Asset Pricing Model). According to CAPM, the expected return of any stock is:
Higher beta = higher expected return — but also higher risk. A stock with beta 2 should earn twice the market risk premium, but also fall twice as hard in downturns.
The limitations of beta
Beta is backwards-looking — it's calculated from historical data and may not reflect future sensitivity. It also doesn't distinguish between upside and downside volatility (a stock that shoots up wildly but rarely falls has high beta — is that bad?). And beta depends heavily on the benchmark chosen: the same stock has different betas relative to different indices.
More fundamentally, CAPM assumes beta is the only risk that matters. Decades of research show that other factors — company size, valuation, momentum, profitability — also predict returns. Beta alone explains only part of the story.
What this means for you
Portfolio beta tells you how much your overall portfolio amplifies or dampens market swings. A portfolio with beta 0.7 will roughly fall 7% when the market falls 10% — and rise 7% when it rises 10%. During bull markets, high beta outperforms; during bear markets, low beta protects. Managing portfolio beta is one of the simplest ways to adjust your risk exposure without changing the underlying stocks you own.