Trading Stocks - How to Buy Safer Stocks?
So you bought yourself a stock and it crashed losing 30 percent overnight. What do you do now? Good question, indeed. And it's a tough one too, so there is really no right general answer. Your trading plan, which you should have prepared before you even started trading, should answer this.
But let's ask an easier question and one that is related to the problem at hand. Namely, is it possible to tell how risky individual stocks are so that we could avoid situations like that in future. Certainly, not too many people enjoy waking up to a disaster like that.
In other words, we would like to know if there are some measures of risk for the stock market. Yes, there are and one such a measure is called the beta or the beta coefficent.
What this coefficient measures is the stock volatility. It measures it relative to a broader market, which has the beta of one. A stock whose beta is one is about as volatile as the general market. Stocks with their betas lower than one are less volatile and those with betas higher than one are more volatile than the general market. The beta is not constrained from the above, in principle, so there are stocks with betas as high as 3 or 4. And even higher. Many stocks like that are penny stocks, which is one reason why penny stocks should be avoided.
Now, the more volatile a stock is, the more risky it is to your portfolio. On the other hand, if you only swing trade or day trade, you want stocks like that as they move more rapidly and generate faster gains. Or losses, depending on your luck.
To be more precise, the beta measures the correlation with the broader market. For this reason, this coefficient can be even negative for stocks that are negatively correlated with the general market, meaning they rise when the market heads south or vice versa. This, for instance, is often true of gold stocks. And since beta is not constrained from the below either, some highly volatile gold stocks can have pretty negative betas.
If you want your portfolio to be immune to excessive volatility, you should look for stocks with betas of one or lower. There are plenty of those out there too. The stocks of companies that produce staples tend to have lower betas. For instance, Procter&Gamble can serve as a classic example. They make soap. And last time I checked, there was really nothing exciting about soap, which is why the stock of a company like that is unlikely to generate much volatility. Another example is provided by utility stocks. Just like soap, energy is needed by everyone and all the time, meaning the stocks of companies that deliver those have little tendency to be cyclical and hence less tendency to fluctuate wildly.
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