Stock Predictions Using Beta
Stock Predictions Using Beta
Using Beta to Predict
If a stock is being bought and sold in a thin market the volatility will be large. A thin market is when there are few bids to buy and few offers to sell. This can exist if there is a high demand for the stock but a limited supply of shares. The few trades that do occur in a thin market can affect prices significantly. Institutional investors tend to avoid thin markets because when they buy and sell large blocks of stock, they can significantly affect the stock’s price. They may also find it difficult to get into and out of a position.
If you were to plot beta of a stock over time, you might see changes as the volume of shares in a typical trade fluctuates.
A change from a low beta to a high beta can mean that a thin market has developed for this investment. If the company is buying back its stock or there is a developing takeover in which a buyer is trying to buy up all the shares, the market for this stock will become “thin” and the volatility will increase.
Depending on why this is happening, it can trigger a buy signal for a wise investor.
A change from a high beta to a low beta can indicate that the stock is not seen as being very popular or that is has resolved a major internal problem that has reduced its susceptibility to outside influences. For instance, if an airline is buying fuel on the commodity market, its costs and market position can fluctuate with the price of oil and be influenced by competition with other fuel users - trucks, utilities, heating, manufacturing, etc. This could result in a high beta.
Now suppose they cut a deal with a major oil company for a long term commitment to buy fuel at some negotiated predictable price. This would remove their dependence on the commodity market shifts and reduce their need to adjust prices and expenses (earnings per share). Their beta would go down. Typically their stock value will go up. The beta would be a predictor of that rise.