Standard Deviation
Standard Deviation, a statistical concept, provides
a reliable measure of volatility.
Overview
Standard Deviation is used as a component of many indicators
in market analysis. In most cases, a high standard deviation implies
high volatility and a low standard deviation implies low volatility.
Basically it's a measure of variability, or how much the price varies
from its moving average.
Here's a quick statistical refresher
Standard Deviation is a basic statistical concept. Consider
a group of students taking an exam. You'll typically find that some score
very high and some score very low, but most scores tend to cluster around
the average. If you plot the results on a chart, you typically see the
bell curve you may remember from high school (even though we don't like
to remember where we were on the bell curve!). This is also referred
to as the normal distribution curve.
Now, back to business..
You can also plot Standard Deviation for security prices.
SD describes how prices are spread around an average (mean) value. The
mean is the intermediate value between the extremes.
One month or twenty working days is the usual period used.
Interpretation
Major tops are typically accompanied by high volatility during
the blow-off phase of a market, as investors become more and more nervous
and ready to take profits. Major bottoms are usually calmer, with low
volatility, as the hopes for quick profits have faded.
- The smaller the difference between closing prices and the mean
price, the lower the SD and the lower the volatility
- The larger the difference between the closing prices and the average
price, the higher the SD and volatility.
Standard deviation is useful for investing in stock options,
because it provides a measure of volatility.
- The higher the volatility for a particular stock, the higher the
option premiums
- The lower the volatility is for a particular stock, the lower the
option premiums
Further information
Also see Average True Range, another
volatility indicator.
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