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Market neutral stock portfolio

What is a market-neutral stock portfolio.

A market-neutral portfolio can be defined as being independent of the general direction of movement of the markets. In a broad sense, it means that the stock moves to a lesser or greater extent with the market in the same direction. Markets in this case are usually represented by stock indices. This relationship is called the beta of the stock. The beta coefficient is an indicator of the degree of risk in relation to an investment portfolio or to specific securities; reflects the degree of stability of the price of these shares compared to the rest of the stock market. Calculated using the formula below.

formula Beta

where:
ra - profitability of the assessed asset;
rp - benchmark portfolio return;
Cov - covariance of the return on the assessed asset and the reference portfolio;
Var - variance of the reference portfolio.

It is not necessary to calculate this indicator manually, since it is available on all financial portals.

Using the beta coefficient when choosing stocks

First you need to figure out what values the beta coefficient has and how to interpret them.

β > 1 - means that the variability of the return on investment in a particular stock is higher than the return on investment in the stock index.

0 < β < 1 - means that the variability of the return on investment in a particular stock is lower than the return on investment of the stock index.

β = 0 - means almost complete independence of the behavior of a particular stock from the entire market. We can say that the stock behaves neutral in relation to the market.

β < 0 - indicates that the market and the stock move in different directions. And when we hear that a stock is going against the market, it means that its beta is negative.

Classification of beta coefficients according to the degree of risk

Stocks with β > 1 can be called aggressive stocks. They grow faster than the market, but they also fall more strongly. Stocks ranging from 0 to 1 have moderate risk parameters. The β coefficient close to zero indicates a low risk of the instrument.