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 to daily highs near 1.1820
EUR/USD now picks up pace and advances to the area of daily peaks north of the 1.1800 barrier at the end of the week. The pair’s decent move higher comes against the backdrop of a generalised lack of direction in the FX galaxy and the mild offered stance in the US Dollar.
GBP/USD trims losses, retests 1.3460
After briefly challenging its key 200-day SMA near 1.3440, GBP/USD now manages to regain some balance and revisit the 1.3460 zone on Friday. Cable’s pullback comes as the selling pressure on the Greenback gathers traction, reigniting some recovery in the risk-linked space.
Japanese Yen gives back half of early gains against USD ahead of US PPI data
The Japanese Yen (JPY) surrenders half of its early gains against the US Dollar (USD) during the European trading session on Friday. The USD/JPY pair rebounds to near 155.90 as the JPY falls back, but is still 0.15% down.
Editors’ Picks
EUR/USD: Fed calm, ECB steady, but the Dollar still leads Premium
EUR/USD is still struggling to find real traction. The pair has tried to stabilise, but momentum keeps fading, leaving the door open to further weakness.
Gold: Falling US yields, geopolitics help XAU/USD hold ground Premium
Gold (XAU/USD) gained traction and climbed above $5,200, ending the fourth consecutive week in positive territory. The next round of US-Iran talks and crucial macroeconomic data releases from the US will be watched closely by market participants in the short term.
GBP/USD: Will Pound Sterling defend key 1.3450 support ahead of US jobs data? Premium
The Pound Sterling (GBP) entered a bearish consolidation phase against the US Dollar (USD), after having tested critical support near the 1.3450 level on several occasions.
Bitcoin: Another month of losses, and it’s been five
Bitcoin (BTC) price is stabilizing around $68,000 at the time of writing on Friday, but the Crypto King is poised to close February on a fragile footing, marking its fifth consecutive month of losses since October and a rare start to the year with back-to-back monthly corrections.
US Dollar: At a crossroads; Fed steady, tariffs in flux Premium
The US Dollar’s (USD) upward momentum from the previous week seems to have encountered a tough nut to crack in the 98.00 region, as measured by the US Dollar Index (DXY).
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