Standard Deviation (StDev) is a statistical measure of dispersion. It also acts as an indicator of technical analysis used by stock, forex or commodity investors. At this point, we have to admit that this is not a very popular indicator, and it can be described as a niche tool. It is not without a reason, but we’ll explain this issue a bit later. Sometimes it seems that some indicators are “forcefully” used. They are not necessarily useful, but the charts overflowing with thousands of indicators and AT tools look “smarter”.
Construction and Operation of Standard Deviation indicator
In comparison to other analytical tools available on investment platforms, StDev is a relatively simple indicator in its construction. The Standard Deviation Indicator shows how closing prices differ from the average closing price of the last n periods. You can set any value as n, however, the most commonly used is the standard deviation for the last 20 periods (mainly at daily interval).
The philosophy of using this AT indicator is based on the theoretical assumption that high variability, i.e. a large deviation from previous closing prices, favors the formation of local peaks, and low standard deviation, i.e. low variability, is conducive to the formation of local troughs. The higher the deviation of the current price from the average closing price, the higher the value of the indicator.
Check also: Bill Williams’ Fractal Indicator
The use of Standard Deviation indicator
Standard deviation is very rarely used as a standalone indicator based on which the transactions would be opened and closed. More often, StDev is used as a component of more advanced investment strategies, based, for example, on Bollinger bands.
It seems that the Standard Deviation indicator shows what you really see with the naked eye. It is more useful for trading using automated investment systems that rely, inter alia, on the measurement of the volatility of prices. In the case of manual trades, it is not very useful.
Advantages of Standard Deviation
- Easily readable signals
- Comprehensible construction of the indicator
Drawbacks of Standard Deviation
- No possibility of use as a stand-alone indicator
- Low usability in the case of manual trade
- Low analytical value
- Large number of erroneous signals