A statistical term used in a wide range of price indicators, a standard deviation is a measure of a given numberâ??s variability around its mean. A higher standard deviation indicates that a number is volatile, while a lower standard deviation suggests that the number is less so. |
In mathematical terms, a standard deviation is the square root of the variance for a variable. The variance measures the squared differences of each individual number from the overall mean, then divides by the sum by the total sample size.
In plainer terms, a standard deviation is a good estimate of a number's average distance from its overall mean. Market technicians like to use the standard deviation of a number for its interesting statistical properties. According to statistical theory, all random variables follow what is called the "Normal distribution", also known as the "Bell curve". As such, one can estimate the probability of a number falling a given number of standard deviations from its mean.
One of the better known applications of a standard deviation is the Bollinger Band price indicator. This popular tool uses the standard deviation to set the distance between the price bands. If the bands are far apart, this tells us that price action has been particularly volatile within the sampling period. If the bands are closer together, Bollinger Bands show relatively stable prices through the same time frame. Based on assumptions from statistical theory, market technicians will estimate that price will stay within their Bollinger bands with a given likelihood.