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What is Standard Deviation for Forex Trading

What is Standard Deviation in forex trading? This article explains how standard deviation can be used to measure the volatility of a currency pair.


Hi, everybody. Forex is the largest and most liquid among global financial markets. Recognized for its daily trading volume in the trillions of dollars, Forex is a financial market that offers us the opportunity to exchange different countries' currencies. One of the analysis methods required to achieve good results in trading this market is technical analysis. Technical analysts attempt to find trends, support and resistance levels, and other patterns from past price movements using charts, indicators, and other technical tools. By using this information, they predict future price movements. There are many technical analysis tools used in financial markets, and we can add technical indicators to that list. Indicators function as mathematical tools, allowing us to measure trends, momentum, and other price movements by examining past price actions. The Standard Deviation indicator is the subject of today's article.

What is Standard Deviation?

The term "Standard Deviation" that we often meet in financial markets is generally used to measure volatility and assess the predictability of price movements. Standard deviation measures how much the prices of a financial instrument usually deviate from the average. The higher the standard deviation, the more volatile and unpredictable the prices become. When trading in the Forex market, we can utilize standard deviation in various ways. For instance, we can use it to predict how much an asset's price is likely to change over a specific period. Also, we consider it when evaluating the probability of an asset's price rising or falling. High volatility means that the currency or asset's price may experience faster and larger fluctuations.

Calculation of Standard Deviation

In trading within financial markets, the need to calculate standard deviation arises with the aim of measuring volatility and evaluating the predictability of price movements. Standard deviation is a measure indicating how much the prices of a currency pair fluctuate within a specific period. The first step involves recording the closing prices of a particular currency pair over a period, for example, 20 days. Then, the average value of these closing prices is calculated. To compute the average value, the sum of these prices is taken and divided by the number of periods. To determine how much each closing price deviates from the average value, each price is subtracted from the average. The squared values of these deviations are calculated. The resulting squared deviation values are summed, and this sum is divided by the number of periods. Finally, the square root of this value is taken to calculate the standard deviation. Here is the formula used to calculate standard deviation:

   σ = √((1/N)Σ(Xᵢ - μ)²)

In this formula:

  • σ represents the standard deviation.
  • represents the sum.
  • N is the total number of days in the period used (e.g. 20 days)
  • Xi, each day's closing price
  • μ is the average value of the period's closing prices.

Don't worry, we don't need to perform these complex calculations ourselves, standard deviation is automatically calculated and displayed by trading platforms and software. Standard deviation is a measurement used to gauge how erratic the price movements of a currency pair are. A higher standard deviation value indicates that the currency pair's price is as erratic as ocean waves, while a lower value suggests that the currency pair's price is as stable as a calm lake.

Using Standard Deviation in Forex Trading

In trading in financial markets, standard deviation is more commonly used to assess volatility and improve risk management strategies. Standard deviation measures how volatile and how frequently the prices of a currency pair change. A high standard deviation indicates high volatility, suggesting that prices fluctuate more. On the other hand, a low standard deviation reflects a more stable market environment. During this time, we can use standard deviation to determine which currency pairs have higher volatility. When investing in a currency with a high standard deviation, we take more risk, while investing in a currency with a lower standard deviation involves less risk. This helps us manage our trading risk.

This chart shows the Standard Deviation of price movements in the AUD/NZD currency pair. High standard deviation indicates that the currency pair's price is more volatile and risky, while a low value means more stable and less risky price movements.
Standard Deviation in the AUD/NZD chart

In addition, standard deviation can be used to assess whether the prices of a currency pair will trend or reverse. If standard deviation is increasing, it indicates that the price trend is strengthening. If you observe a trend with high standard deviation, the trend is more likely to continue. Conversely, if you see a clear deviation in prices with high standard deviation, it could be a signal of a reversal. Indicators are used to determine optimal entry points by tracking price movements. Standard deviation, on the other hand, evaluates how much the current prices deviate from the average price, so we can estimate the probability of prices returning to the average value in the future.

Keep in consideration. In financial market trading, the standard deviation indicator is a reasonable tool for measuring volatility and analyzing price movements. This indicator can be a useful tool for market analysis, but it cannot fully capture the complexity of price movements. Market dynamics are dependent on a variety of factors, and a single indicator can only provide a limited view. Standard deviation can sometimes give false signals. It can be risky to use the indicator, especially during periods of low liquidity or under the influence of news. Relying solely on the standard deviation indicator in trading leads to the incompleteness of your risk management strategies. It is important to combine standard deviation with other technical indicators to achieve better results when trading in financial markets. Trading success to you!

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