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. 

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

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