The standard deviation indicator
Standard deviation is an indicator that measures the size of recent price moves of an asset, to predict how volatile the price may be in future.
It can help you decide whether the volatility of the price is likely to increase or decrease.
Big price moves follow small price moves, and vice versa
The standard deviation indicator compares the current price movement and its historical price movement.
The image below shows how the standard deviation indicator appears on a chart:
The standard deviation is the blue line that goes up and down, indicating whether price movement in the past is higher or lower than the current price movement.
When the blue line is high, a big change in the price of the asset has usually just occurred. It is likely that the price volatility will soon fall.
High standard deviation
The image below shows the indicator giving a high reading following a big price move:
- High standard deviation. Notice that in the shaded area, the price moves far compared to the most recent candles before.
Notice in the chart above that in the shaded area, the price moves up a lot compared to the previous few candles. This is what the standard deviation measures and you can see the standard deviation line move up.
Low standard deviation
When the standard deviation is low, the price has usually been stable, meaning that there has been more of a ranging market.
A very low reading can also indicate that volatility could be rising very soon.
The image below shows the indicator giving a low reading, followed by a big price move:
- Low standard deviation. Notice that in the chart, the price does not move very far until the end of the green shaded area. In this time, the blue line remains low.
You can see that in the chart above, the price did not move very far. This is what the indicator measures and so the blue line is low. Towards the end of the green shaded area, the price suddenly moves down. The price has moved much further compared to the previous period and the blue line then rises at this point.
Changing the standard deviation indicator settings
The standard setting on the indicator is 20. This is the number of recent periods the indicator calculates the deviation over. So on a daily chart, the indicator will calculate the standard deviation over the last 20 days.
Changing the indicator's setting to above 20 will make it less sensitive. Changing it to below 20 will make it more sensitive.
Increasing the setting
The image below shows how increasing the setting to 40 affects the indicator’s readings:
As shown above, with a setting of 40, the indicator produces a much smoother line. However, it produces extremely high or low readings far less often.
Decreasing the setting
The image below shows how a decrease in the number of periods affects the indicator’s readings:
With a setting of 10, the standard deviation line reaches extremely high or low levels far more frequently. This results in more trading opportunities but also more false signals in whether the volatility will rise or fall afterwards.
Generally, traders tend to keep the standard setting of 20 in place. This is because it has been found to provide a more reliable reading than most other settings.
Testing new settings
If you do decide to test out different settings for the standard deviation indicator, it is vital that you ensure any changes you make has a positive impact on your trading results.
In this lesson, you have learned ...
- … the standard deviation indicator measures the volatility of an asset’s price to predict the size of future moves.
- … it appears on charts as a blue line.
- … a high standard deviation reading usually means a big price change has just occurred, but that a decrease in volatility could soon follow.
- … a low standard deviation reading usually means price volatility has recently been low, but that a big price move could soon follow.
- … the standard deviation indicator only helps predict the size of upcoming price moves – not their direction.
- … the standard setting for the indicator is 20, meaning it calculates price deviation over 20 recent periods.
- … using a setting higher than 20 will make the indicator less sensitive.
- … using a setting lower than 20 will make the indicator more sensitive.
- … the standard setting of 20 is considered most reliable and most traders keep it in place.