Finance: What is the Security Market Line, aka SML?

What is the Security Market Line, aka SML? The SML is another tool of technical analysts. It is used to chart securities relative to the mean return vs. risk ratio in the market. This will help to show if a security is undervalued or overvalued relative to their trading volatility and perceived risk when compared to the market.

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Transcript

00:18

you should and click on the ads The guy doesn't

00:21

work for cheap you know Yes ml is just a

00:23

graph depicting the risk or volatility adjusted investment returns inside

00:27

of the capital asset pricing model structure or cap in

00:30

overly simply investment opportunities Living up here above the sml

00:35

are probably at least according to this line undervalued And

00:39

securities living below this line are overvalued The line itself

00:42

is sort of ah fairness or at least where everything

00:45

is fairly priced relative to its risk or beta and

00:48

its reward or you know reward the assessment of risk

00:52

Here is the hard part that's risk or beta and

00:55

the quick and g rated dirty on beta is that

00:58

a stock with a beta of one moves in about

01:00

the same direction and amount is the overall market in

01:03

which it lives Think like a tech stock like oracle

01:06

inside of the market of say nasdaq On any given

01:09

day the market might be up one percent If so

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then if oracles displaying a beta of one well then

01:15

it to will be up about one percent and vice

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a versa We'll stock with a beta of two will

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move twice a cz muchas the market aiyana down one

01:23

point five percent day for the market While that stock

01:25

should be down something like three percent notionally bait is

01:28

another word for risk and higher beta stocks imply that

01:31

they're mohr risky But that's a really narrow view because

01:34

over time the market itself goes up There's a long

01:37

term view in a short term view right So yeah

01:40

let's look at this beautiful century issue of stock prices

01:44

of the s and p five hundred Yeah it's up

01:47

not the movie So when someone claims that the stock

01:49

is riskier because it has higher beta well that may

01:52

be true in the day to day trading short run

01:55

But in the long run of riel investors who buy

01:58

and hold stocks a long period of time higher beta

02:00

stocks moving mohr than the market as a basket do

02:04

better than the market But why do we point this

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out Because this model really doesn't work At least not

02:10

for real investors Actually trying teo what's called Oh yeah

02:13

Invest real time Yeah the models A reflection of what

02:16

happened in the past Sort of like driving while looking

02:19

in the rear view mirror You see miles and miles

02:22

of road behind you looking nice and straight as you

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You know head out on the highway looking for investing 00:02:28.04 --> [endTime] Adventure and all is good until it's not