What does the term "beta" signify in finance?

The term "beta" in finance is used to measure a stock's volatility or systematic risk in relation to the overall market. Specifically, it quantifies how much a stock's price tends to move in comparison to changes in the market index, such as the S&P 500. A beta of 1 indicates that the stock's price will move with the market; a beta greater than 1 indicates higher volatility than the market, while a beta less than 1 means the stock is less volatile.

Understanding beta is crucial for investors who want to assess the risk associated with a particular investment in relation to market fluctuations. By evaluating a stock's beta, investors can make more informed decisions about portfolio diversification and risk management. For instance, stocks with a high beta may offer higher potential returns but come with greater risks, while stocks with a low beta may be more stable but could yield lower returns over time. This relationship between beta and market risk is fundamental to the Capital Asset Pricing Model (CAPM), which helps investors understand expected returns based on systematic risk.