The basic definition of risk has two parts:

1. The likelihood of suffering a loss.
2. The magnitude of that loss.

Traders often overemphasize No. 1, focusing simply on the odds of a position moving against them. But rarely do they consider the potential magnitude of a loss. That’s why we should measure how positions react to moves in the broader market.

### Measuring Risk with Beta

Beta is a common solution for gauging volatility because it tells us how much a symbol will fluctuate relative to a move in a benchmark like the S&P 500.

A stock with a 1.5 Beta will move 1.5 percent for every 1 percent the wider market goes up or down. Knowing this number can help us assess the risk if a major volatility event occurs.

### Calculating Beta

Long-term stock investors calculate Beta with a regression based on price returns of the stock divided by the price returns of the overall market. But there are problems with this approach:

1. Because newer data isn’t considered, you’re always seeing a dated value.
2. This approach uses several years of historical data — generally a poor predictor of current price action.
3. This calculation only accounts for overall Beta. It fails to distinguish between moves up and moves down.

Want a better technique? Why not determine Beta over a shorter time period, and then separate out the values for up days and down days?

While there are several ways to perform a short-term Beta calculation, most traders find this method much more useful.

### Measuring Risk on a Single Trade

No one likes to think about losing a lot of money on a single trade. But it can happen. That’s why you need to consider the reality of potential trade risk. What you don’t know definitely can hurt you in the market.

Say you hold 200 shares of a stock at \$140 per share, and it has a Beta of 1.5 against the S&P 500. If the S&P 500 gaps down 5 percent over the weekend, how would that move affect your position and account?

As you know, a 5 percent drop in the index, times the stock’s Beta of 1.5, would translate into a 7.5 percent decline for your position. Multiply that by the 200-share position, and the loss potentially exceeds \$2,000.

The real question is: How much does that loss hurt your overall account? Knowing that information lets you determine whether your position size and risk are appropriate for your account. And although a stop loss won’t protect against a gap overnight or during the weekend, it definitely can limit risk during market hours.