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Your email address Please enter a valid email address. Message Optional. Related Indicators Historical Volatility An annualized one standard deviation of stock prices that measures how much past stock prices deviated from their average over a period of time. Please enter a valid ZIP code. All Rights Reserved. Volatile prices mean standard deviation is high, and it is low when prices are relatively calm and not subject to wild swings.
While standard deviation is an important measure of investment risk, it is not the only one. There are many other measures investors can use to determine whether an asset is too risky for them—or not risky enough. Standard deviation is calculated by first subtracting the mean from each value, and then squaring, adding, and averaging the differences to produce the variance.
While variance itself is a useful indicator of range and volatility, the squaring of the individual differences means they are no longer reported in the same unit of measurement as the original data set.
For stock prices, the original data is in dollars and variance is in dollars squared, which is not a useful unit of measure. Standard deviation is simply the square root of the variance, bringing it back to the original unit of measure and making it much simpler to use and interpret.
In investing, standard deviation is used as an indicator of market volatility and thus of risk. The more unpredictable the price action and the wider the range, the greater the risk.
Range-bound securities, or those that do not stray far from their means, are not considered a great risk. That's because it can be assumed—with relative certainty—that they continue to behave in the same way. A security with a very large trading range and a tendency to spike, reverse suddenly, or gap is much riskier, which can mean a larger loss.
But remember, risk is not necessarily a bad thing in the investment world. The riskier the security, the greater potential it has for payout. When using standard deviation to measure risk in the stock market , the underlying assumption is that the majority of price activity follows the pattern of a normal distribution. A stock with high volatility generally has a high standard deviation, while the deviation of a stable blue-chip stock is usually fairly low.
So what can we determine from this? The smaller the standard deviation, the less risky an investment will be, dollar-for-dollar. On the other hand, the larger the variance and standard deviation, the more volatile a security. As with anything else, the greater the number of possible outcomes, the greater the risk of choosing the wrong one.
Advanced Technical Analysis Concepts. Portfolio Management. Risk Management. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. Working out standard deviation is easy using a standard deviation formula like the following:. There are plenty of online calculators that will apply the formula for you. Step by step, you can also calculate the standard deviation as follows:. Calculate mean value by adding together all data points in the set and dividing them by the total number of data points.
Calculate the variance for each data point by subtracting the mean value from the data point value. Square each resulting variance and add the points together. Divide this from the number of data points minus one. It would have a standard variation of zero for this time period, because there is no variance from the mean.
As another standard deviation example, if this same fund lost 1. Its standard deviation would be much higher to reflect this volatility. This measure will always be impacted by outlying, extreme values, but not all uncertainty is risk. GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices.
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