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David Gaines
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Novice investor looking to learn more about effective trading strategies and eliminate all the mistakes made throughout the years.
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  • Using Beta To Bring Some Stability To A Portfolio 0 comments
    May 3, 2013 10:35 AM | about stocks: MF, EJ, ARR, XIN

    Of the initial stocks that I purchased, I just looked at their Beta. Yes, after I invested my hard earned money, but I'm learning how to be patient.

    And to my surprise, well not really, I chose stocks that like to make some noise. Alumina Ltd (AWC) and E-House (China) Holdings (EJ) both have a Beta that's above 2.0 which is an indicator of their volatility. And anything above 2.0 means you should expect some volatility.

    Wikipedia defines Beta as the following:

    The Beta (β) of a stock or portfolio is a number describing the correlated volatility of an asset in relation to the volatility of the benchmark that said asset is being compared to.

    In lay terms for novices like me, a Beta of 1.0 means the stock rises and falls with the motion of the market. If the S&P 500 goes up, the stock goes up. If the S&P 500 goes down, that stock will go down. If a portfolio has a bunch of stocks with a Beta of 1.0, all you have to do at the end of the day is see if the indices went up or down.

    When the Beta is more than 1.0, that generally suggests that the stock will move in the same direction of the indices, but with more movement. If the Beta is 2.0 and the markets are bullish, the stock will be more bullish. Stock with a Beta of 2.0 tend to be very bullish.

    Those same stocks with a high Beta will also drop like a rock when the indices are bearish. If there's a drop in the indices, a stock with a high Beta have the tendency to get buried.

    Of course this is just a gauge. I'm still learning what to do with what I'm learning. It sounds like Beta just means stocks go up and down with the market only with a higher degree of intensity, but it's not that simple. It doesn't mean a stock won't catch fire and rise to the top of the food chain; it doesn't mean a stock won't catch fire, crash and burn. That's what all the other fundamentals that I'm literally learning on the fly is for.

    But Beta does help you determine how much heart burn you're going to experience. With two out of three of my stocks with a Beta higher than 2.0, it was like a bull out the gates of a rodeo, that turned into a bear, that was again a bull, then a bear.

    To bring my portfolio's overall Beta down, I looked for a stock with a lower Beta. There's no true science of how I chose to purchase some ARMOUR Residential REIT (ARR) stock. I liked what I saw as far as dividend potential, I wanted to diversify geographically (in this case a company based in the United States), and the Beta of 0.20 balancing out my portfolio's high Beta number.

    So what does it mean when the Beta is lower than 1.0? As the Beta gets smaller, the answer changes. When it's between 0.0 and 1.0, Wikipedia explains it as the following:

    Movement of the asset is generally in the same direction as, but less than the movement of the benchmark.

    An example given is:

    Stable, "staple" stock such as a company that makes soap. Moves in the same direction as the market at large, but less susceptible to day-to-day fluctuation.

    To me that says boring, but it also says reliability. To a degree. These are stocks you don't have to check every couple of hours because it's price changes faster than you can refresh your browser. These stocks are anchors to the wild ride that stocks with high a Beta will take a portfolio on.

    Well, what about a Beta of 0.0? These are immune to peer pressure. Their movement is not correlated to the market, like a fixed-yield asset.

    And if the Beta is less than 0.0? These are your stocks that do the exact opposite of what the market is doing. Gold, for instance, tends to go up when there's turmoil on the markets and go down when the markets are doing well. These stocks are used for hedging, balancing out a portfolio for those rainy days when everything else is falling as witnessed during the most recent recession.

    In addition to ARMOUR Residential REIT (ARR), I added Xinyuan Real Estate Co Ltd (XIN), whose Beta is 1.3. Again, the science behind the decision wasn't complex. Dividend potential looked good, some of the other fundamentals which I'll get to eventually looked solid (at least to a novice eye like mine) and I was looking for something close to a Beta of 1.0.

    My portfolio has an average Beta of 1.19. Does that mean it's improved? No. But it does mean my portfolio isn't going to look like one of my child's drawings, random scribbles across a blank canvas that only has value to the owner.

    Stocks: MF, EJ, ARR, XIN
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