'Eat well or sleep well?' - this trading signal helps choose stocks based on your risk tolerance

Risk tolerance is an important concept
Beta can help investors choose the right stocks
The highest and lowest Beta stocks on the ASX

There are two types of investors out there – one who is risk averse and the other who is risk tolerant.

Risk averse investors tend to focus on preservation of capital, preferring to invest in stocks with lower volatility. This type of investor may even emphasise the importance of diversification in their portfolio.

Risk tolerant investors, on the other hand, are comfortable with taking on higher levels of risk in pursuit of potentially higher returns. They accept greater short term volatility and fluctuations in return for longer term gains.

There is no right or wrong here, everyone is unique, and the type of investor you are just depends on your personality and the goals you’ve set for yourself.

But there’s an old Wall Street adage that says: “You can eat well or you can sleep well.”

The meaning is self-explanatory, but the key takeaway is that you need to determine what your own risk tolerance is.

And how do you do that?

Well, the questions to ask yourself are: what are your investment objectives, when do you need the money, and how would you react if you lost a big chunk of money, even on paper?

The last one is crucial, because determining your risk tolerance also involves thinking about hypothetical and worst case scenarios.

For instance, how would you feel if you lost 20% or 30% of your portfolio value, and how would that impact your family?

Introducing Beta

There’s a trading tool used by market experts to assist in choosing the right stocks that fit with investors’ risk tolerance levels.

The tool is called Beta – which is essentially a measure of a stock’s volatility in relation to the overall market.

The formula is much too convoluted to publish here, so it’s suffice to explain that if:

Beta = 1: The stock moves in perfect correlation with the market.

Beta higher than 1: The stock is more volatile than the market. When beta is 2, for example, it indicates the stock moves twice more than the market, in either direction.

Beta less than 1 : The stock is less volatile than the market. A beta of 0.6, for instance, suggests the stock moves only 60% as much as the market, in either direction.

How can investors interpret this knowledge and use it in their investing decisions?

For the risk averse investor, choosing stocks with Beta less than or equal to 1 might be the most suitable option.

For risk tolerant investors, choosing stocks with Beta higher than 1 might better reflect their investment philosophy.

Where can I get Beta numbers for each stock?

Your online broker should be able to provide you with Beta data on each stock.

On Commsec for example, traders can sort stocks by their Beta values.

Here’s the latest data from Commsec, which sorts stocks by their highest and lowest Beta values.

Stocks with highest Beta values (most volatile)

Note: this list is not a comprehensive list

Code	Name	Beta > 1
BP8	BPH Global	2.00
CT1	Constellation Tech	2.00
AJL	AJ Lucas	2.00
AMP	AMP Ltd	2.00
MGL	Magontec	2.00
A1N	ARN Media	2.00
DOU	Douugh	2.00
CDD	Cardno	2.00
CGF	Challenger	2.00
CGO	CPT Global	2.00
IGN	Ignite	2.00
AGD	Austral Gold	2.00
AJX	Alexium	2.00
EWC	Energy World	2.00
TOY	ToysRUs Anz	2.00

Stocks with lowest Beta values (least volatile)

Note: this list is not a comprehensive list

Code	Name	Beta < 1
VPR	Volt Power	0.5
BXN	Bioxyne	0.5
DEM	De.mem	0.5
FHE	Frontier Energy	0.5
BIO	Biome	0.5
LGI	Lgi	0.5
CCE	Carnegie Clean Energy	0.52
TPC	TPC Consolidated	0.53
CCO	Calmer Co	0.54
SKN	Skin Elements	0.54
D2O	Duxton Water	0.54
CHL	Camplify	0.55
TUA	Tuas	0.56
AN1	Australian Nutrition & Sports	0.56
S66	Star Combo Pharma	0.57