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.
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| 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!