When calculating risk, you can use all kinds of tools to compare a stock's current volatility to its past volatility. However, one of our favorites is fast beta.
When calculating risk, you can use all kinds of tools to compare a stock’s current volatility to its past volatility. However, one of our favorite charting indicators in thinkorswim®—beta—allows you to compare a stock’s volatility to the volatility of a market index, such as the S&P 500 (SPX), the Dow 30 (DJX), the Nasdaq 100 (NDX), or the Russell 2000 (RUT).
Consider a little refresh. Compared to the S&P 500, say a stock has a beta of 1.25, and the S&P 500 moves up 1%. So, theoretically, the stock would move up 1.25%. But you think it could be a little better—more useful. How? By creating “fast beta.”
FIGURE 1: FAST BETA, PLEASE. When trading shorter-term volatility, the fast-beta indicator in thinkorswim Charts can provide more relevant information than regular beta. For illustrative purposes only. Not a recommendation.
The downside of using regular beta when trading shorter-term vol is that it uses a long set of price data that is unweighted, thereby considering older price movements as equally valid to more recent price movements. This discounts the possibility that current volatility might be significantly different relative to the long term. So, in effect, fast beta places more emphasis on recent price movements and requires less historical data. The interpretation of fast beta is roughly the same as that of regular beta. But keep in mind that the time over which we measure is shorter, which might work better when calculating, say, a hedge on a short-term trade.
The “modified” portion that gets us to fast beta is the use of a weighted moving average instead of a simple moving average. Using a weighted moving average gives fast beta a calculation more sensitivity to recent price movements in a security, as well as in its benchmark.
Just like beta, fast beta measures the systematic risk of a security, and the sensitivity of that security's returns to market returns. As well, a benchmark "market" is selected and defined to have a fast beta equal to 1.0. Just like beta, stocks with fast beta greater than 1.0 are more volatile than the market. Whereas those with lower fast beta are less volatile. In short, if a security has a fast beta of 2, and the market is down 10%, the security is expected to be down 20%. Stocks with fast beta equal to 1.0 are said to move with the market.
1/ Go to the Charts tab on thinkorswim.
2/ Enter a symbol and press <enter> to pull up a chart.
3/ In the upper right, above the chart, click Studies>Add Studies>Alpha Studies>FastBeta.
The default index used to compare is SPX. However, you can choose one of the other four main indices (NDX, RUT, DJX, and Nasdaq Composite) through the “Edit Studies” under the studies menu as well.