Standard deviation is an indicator used by traders to statistically measure how widely prices are dispersed from the average price. The indicator gives traders insight into the market by measuring the size of an asset’s recent price moves to predict how volatile the price may be in the future. Traders are guided by the indicator in deciding whether the price volatility is likely to increase or decrease. (Try out indicators on Tradingview.com)
Features of standard deviation indicator
• Moving average
• Current price movements
• Historic price movements
• Market volatility
Calculation of Standard deviation Indicator
Calculation of the standard deviation indicator is direct and straightforward with the following formula:
SD = Sqrt [(Sum the ( (Close of the previous n Periods – n Period SMA for the current bar) ^2))/ n]
Follow the following steps.
• Find SMA for number of Periods, n
• Subtract the value of SMA calculated above from the Close for each of the previous n Periods, then find the square.
• Add the squares of the differences and divide by the n
• Calculate the square root of the result from step three
Where:
SQRT – square root.
SUM (…, N) – sum within N periods.
SMA (…, N) – simple moving average having the period of N.
N – calculation period.
How does the Standard Deviation Indicator work?
When the prices become volatile, the standard deviation rises. On the other hand, when prices are calm, the standard deviation gets lower. When there is an increase in price with an increased standard deviation, it depicts a weakness or above average.
Market tops go along with increased volatility over a short period of time, indicating nervous and indecisive traders in the market. When there are market tops and decreasing volatility for a prolonged period of time, it indicates maturing bull markets.
Market bottoms in conjunction with a decreased volatility for a prolonged period of time indicate bored and disinterested traders. A market bottom with increasing volatility over a short period, it’s an indication of panic sell-offs.
When to use standard deviation indicator?
The indicator is considered as one of the most reliable indicators for traders but under certain conditions. When volatility is moderate in a trending market and price oscillation is concentrated at the middle of the range, the standard deviation is the best tool to use at that moment.
For example, suppose a currency is oscillating between 1.4800 and 1.6300 for a prolonged period of time, with much of the movement centered in the middle of the range. In that case, you can trade the pattern based on standard distribution by assuming mean regression.
Use of the Standard Deviation Indicator
The use of probability distribution models allows traders to create various trading strategies. With the standard deviation application, there is more insight when predicting price reversals based on the principle of reversion to the mean.
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