November 11, 2025
5 mins read
Analysing the trends and patterns in the stock market is crucial for every trader, as it helps decide the entry and exit points better. Standard deviation is an important feature of technical analysis that is used to figure out different kinds of moving averages. At first, it could seem hard, but if you know how it works and how to use it, standard deviation is easy. Let's look more closely at standard deviation and how to understand it.
Prices go up and down all the time on the stock market. Standard deviation is a way to figure out how much a price tends to change. It's an important feature of market analysis that may help you make better trading choices.
It may sound like a hard math word, but the notion behind it is actually very easy. It may be a really helpful tool for trading if you know how to utilise it. Let's talk about what standard deviation is and how to apply it.
Picture this: you have the test scores for a whole class. If everyone got between 70 and 80, the standard deviation would be minimal since the scores are all near to the average. But if the scores are all over the place—from 30 to 100—the standard deviation would be high.
In the stock market, it works the same way. A stock with a low standard deviation has a price that doesn't change much. It's stable. A stock with a high standard deviation has a price that swings up and down a lot. It's volatile. For traders, this is a key way to measure risk.
You can use standard deviation in many ways:
Managing Risk: A common use in trading is to measure volatility. A high standard deviation means high volatility and, therefore, higher risk. A low standard deviation means lower volatility and lower risk. This helps you decide if a stock fits your risk tolerance.
Managing Your Portfolio: You can use it to track the performance of your entire investment portfolio. It shows you how much risk you're taking overall and whether your investments are on track to meet your goals.
Financial Analysis: Businesses use standard deviation to help them make important choices in finance. It helps them figure out how risky a new project is and how to use their money to grow in the future.
Your trading platform will figure out the standard deviation for you, but it's good to know how it works. It helps you understand what the number really means.
The formula for finding the standard deviation is:
σ=N∑i=1N(xi−μ)2
Here's what each symbol means:
σ (Sigma) is the symbol for Standard Deviation.
∑ (Sigma) is the symbol for "sum of", meaning you add everything up.
xi represents each individual data point in your set (like a stock's closing price each day).
μ (Mu) is the mean, or average, of all the data points.
N is the total number of data points in the set.
Calculating standard deviation by hand involves a few steps. It can look intimidating, but each step is quite simple. You don't usually have to do this yourself because trading software does it for you, but here's how:
Step 1: Find the Average (Mean) Add up all of your data points, such as the last 20 closing prices of a stock, and then divide that number by the number of data points. This is how much the average price is.
Step 2: Find the variance for each point. Then, for each data point, take the mean away from it. Do this for every piece of data in your set.
Step 3: Square Each Difference Now, square each of the numbers you got in Step 2 by multiplying it by itself. When you square them, all the numbers become positive.
Step 4: Add everything up and find the average. It Add together all the numbers you squared in Step 3. After that, divide that total by the number of data points.
Step 5: Find the Square Root Finally, find the square root of the number you got in Step 4. That's all! The last number is the standard deviation.
Standard Deviation Formula
While you can rely on the standard deviation graph prepared by analytical tools on trading platforms, knowing the formula can help you enhance accuracy.
The formula to calculate standard deviation is:
√[Σ(xi - μ)2 / N]
Here,
N Size of the population
xi= Each value from the population
μ= The population mean
Standard deviation is a very useful tool, but it isn't perfect. Before you use it to make all of your trading decisions, you should remember that it has some limitations, just like any other indicator.
One of the big problems is that it treats all changes in price the same. It doesn't understand the difference between a good price move (when a stock you own goes up) and a bad one (when a stock you own goes down). It only looks at how much the price changes, no matter which way it goes.
Another big problem is that it is very sensitive to outliers, which are big changes in price. A single, very unusual day of trading can make the standard deviation much higher, which might give you a misleading picture of the stock's typical volatility. Because the formula squares the differences, these extreme values have a much bigger impact on the final number.
Standard deviation is a very useful tool for any trader or investor. It gives you a clear and simple way to measure market volatility and risk. The main point is easy to understand: a big standard deviation means prices go up and down a lot, while a small one means prices stay more stable. It has some flaws, but when used with other technical indicators, it can help you make better decisions and lower your risk in the market.
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