The Standard Deviation Volatility Indicator

We look at this indicator and how it can be used in trading.

Source: Bloomberg

Standard deviation is a way of measuring the size of price moves, in order to try to help define whether the price will become more or less volatile in the future. It does not predict direction, but can aid in determining whether volatility in a price is likely to go up or down.

Standard deviation as an indicator has been added to the IG chart below. It can be seen that volatility for the S&P 500 rose dramatically during February, and then to a lesser degree in late March, from periods of relative calm in January and early March.

When the blue line moves up quickly, it is an indication that a large movement in the price has occurred, and that a period of quiet may now follow.

The standard setting is a 20-day indicator, using the average of the past 20 days of trading. Like other indicators on the IG platform, this can be adjusted higher to smooth the data, or downward to increase the speed of movement.

This can be seen below. In the first example, the indicator’s value has been increased, so that the number of extreme readings has been reduced. Meanwhile, the second example shows that the indicator has been reduced in value, with more extreme readings.

The first method reduces the number of trading opportunities but also decreases the number of false signals, while the second increases the number of possible trades available but also raises the number of false signals that will result in more unsuccessful trades.

It is down to the trader’s personal preference as to which one is used.

As with so many indicators, the 20-period setting is used as it acts as a sensible medium between the extremes, since an indicator that gives too many signals is likely to reduce profitability. 

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