Trading is complicated, with various tactics and approaches. “Betting Against Beta” (BAB) is a popular trading method that includes shorting high-beta equities for positive anomalous returns. This article introduces Betting Against Beta to beginners.
Understanding Beta
Beta must be defined before using the Betting Against Beta approach. Beta quantifies a stock or portfolio’s systematic risk relative to the market. Stocks with a beta over 1 are more volatile than those below 1.
Thus, the Betting Against Beta approach assumes high-beta stocks are overvalued and low-beta stocks are underpriced. This implies investors might earn by shorting high-beta companies and buying low-beta ones.
Using Bet Against Beta
The Betting Against Beta technique requires numerous steps:
Step 1: Find high- and low-beta stocks
Find stocks with high and low beta. Financial websites and trading platforms provide beta. Technology, biotech, and emerging markets have high-beta stocks, whereas utilities and consumer goods have low-beta stocks.
Step 2: Portfolio creation
After identifying high-beta and low-beta equities, short the former and buy the latter. The short-to-long ratio depends on risk appetite and market circumstances.
Step 3: Consider leverage
Leveraging is an option for riskier investors. Margin or derivatives may boost returns. Leverage should only be used if you fully comprehend its hazards.
Risks and Limits
The Betting Against Beta approach may provide positive anomalous returns, but there are dangers and limitations:
The technique believes an inefficient market misprices high-beta equities. Due to market efficiency, the technique has lost efficacy in recent years.
Timing is key with this method. Patience is needed to remedy high-beta stock mispricing. Trades made early or late might lose money.
Unexpected occurrences or market shocks might alter the beta-stock price connection.
Conclusion
Traders seeking mispriced equities may use the Betting Against Beta technique. Before executing the approach, you must comprehend its dangers and do significant study. Market circumstances and efficiency affect strategy effectiveness.
Sources and References
The information provided in this article was gathered from the following sources: