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 climbs toward 1.1800 on broad USD weakness
EUR/USD gathers bullish momentum and advances toward 1.1800 in the second half of the day on Tuesday. The US Dollar weakens and helps the pair stretch higher after the employment report showed that Nonfarm Payrolls declined by 105,000 in October before rising by 64,000 in November.
GBP/USD climbs to fresh two-month high above 1.3400
GBP/USD gains traction in the American session and trades at its highest level since mid-October above 1.3430. The British Pound benefits from upbeat PMI data, while the US Dollar struggles to find demand following the mixed employment figures and weaker-than-forecast PMI prints, allowing the pair to march north.
Japanese Yen seems poised to appreciate further; awaits BoJ decision on Friday
The Japanese Yen maintains its bid tone through the first half of the European session on Tuesday which, along with a bearish US Dollar, keeps the USD/JPY pair depressed below the 155.00 psychological mark. The growing acceptance that the Bank of Japan will raise interest rates this week turns out to be a key factor behind the safe-haven JPY's outperformance.
Editors’ Picks
EUR/USD climbs toward 1.1800 on broad USD weakness
EUR/USD gathers bullish momentum and advances toward 1.1800 in the second half of the day on Tuesday. The US Dollar weakens and helps the pair stretch higher after the employment report showed that Nonfarm Payrolls declined by 105,000 in October before rising by 64,000 in November.
GBP/USD climbs to fresh two-month high above 1.3400
GBP/USD gains traction in the American session and trades at its highest level since mid-October above 1.3430. The British Pound benefits from upbeat PMI data, while the US Dollar struggles to find demand following the mixed employment figures and weaker-than-forecast PMI prints, allowing the pair to march north.
Gold extends its consolidative phase around $4,300
Gold trades in positive above $4,300 after spending the first half of the day under bearish pressure. XAU/USD capitalizes on renewed USD weakness after the jobs report showed that the Unemployment Rate climbed to 4.6% in November and the PMI data revealed a loss of growth momentum in the private sector in December.
US Retail Sales virtually unchanged at $732.6 billion in October
Retail Sales in the United States were virtually unchanged at $732.6 billion in October, the US Census Bureau reported on Tuesday. This print followed the 0.1% increase (revised from 0.3%) recorded in September and came in below the market expectation of +0.1%.
Ukraine-Russia in the spotlight once again
Since the start of the week, gold’s price has moved lower, but has yet to erase the gains made last week. In today’s report we intend to focus on the newest round of peace talks between Russia and Ukraine, whilst noting the release of the US Employment data later on day and end our report with an update in regards to the tensions brewing in Venezuela.
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