Let's look at how investors and traders use beta.

In practice. The calculation of equity beta is backward looking.

It's based on historical data.

While that's a useful starting point, markets move forwards, not backwards.

So when using beta for investment or trading decisions, we need to think about how well that historical relationship is likely to hold in the future.

How similar is the company today to the company? It was over the last two years, the period we might have used to calculate its historical beta.

Has it completed a merger or a spinoff? Has its business mix changed or has corporate activity made its earnings more or less volatile? All of these factors could justify overriding the historical number and forming a forward-looking estimate of beta one that better reflects how the stock might behave from here.

And remember, a beta based view is only a view on market sensitivity.

It says nothing about stock specific events which remain even if you were to hedge market risk.

Investors use beta to manage portfolio risk and return every portfolio's.

Overall volatility is driven by the beta of the individual positions it contains.

If you are bullish on a particular sector, say high growth technology, you might accept higher volatility because you expect stronger returns.

But if you are building a balanced portfolio, you need to be aware of how much volatility you're taking on relative to the market.

For instance, imagine a stock with a beta of two.

That means on average it moves twice as much as the market up or down.

Investors who hold it must be comfortable suffering roughly twice the market swings to earn their expected return.

Others with lower risk tolerance might prefer to reduce exposure by combining it's with lower beta holdings.

Traders on the other hand, often use beta for hedging to reduce or remove market risk from a position, but this is rarely an apples to apples exercise.

The hedging instrument is usually completely different from the asset being hedged.

You might be long one stock, but hedge that exposure by shorting another stock in the same sector or by shorting an equity index future.

The trick is to size the hedge correctly, and that's where beta adjusted market values come in.

To neutralize market risk, you calculate the beta adjusted long market value of your position and then take an offsetting beta adjusted short market value in your chosen hedge.

By definition, the market itself has a beta of one.