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Tips to Understand and Define Standard Deviation

Those who trade currencies mainly rely on market volatility as the source of endless opportunities to make a good profit. At the same time, market volatility brings some crucial challenges to traders. Sometimes, it is pretty hard to predict fluctuation, as it may occur from nowhere and rapidly influence the exchange rate. It all results in price turbulence that can bring plenty of risks to those who trade currencies.

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You will need a reliable and effective tool to manage that turbulence. In this context, the standard deviation can appear to be the right methodology when identifying price turbulence. The tool makes it possible to spot typical or abnormal market moves. As a trader, you will have a chance to make wise decisions related to every new trade.

What is a standard deviation? How to define and implement it in the Forex market? These are the major questions we are going to discuss in today's article.

What Is Standard Deviation?

In order to define standard deviation, we need to clarify what it actually is. It is a mechanism utilized to measure the distance between the mean value and the data point within a specific time frame. It was initially introduced by Karl Pearson back in 1894. Apart from financial markets, the methodology can be utilized in other technological and scientific fields. No matter where and why it is used, the standard deviation consists of several baseline components. They are as follows:

  1. The square root of value variances. To define standard deviation, you need to look for the Greek letter sigma, which is the symbol of the mechanism.
  2. A squared letter sigma symbolizes the variance of differences of all squares.
  3. To find the mean, you need to add all individual values and then divide them by all instances you can observe. As a result, you will have the mean in a form of a simple average that is characterized by the Greek letter mu.

The main benefit of this tool is the even beginners will find it quite easy to interpret the data. The process is intuitive and does not require special skills or background. All you need is to keep in mind that higher variability degrees are usually characterized by larger deviation volumes and vice versa – low variability comes with small deviation values.

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How to Define Standard Deviation and Implement in Forex

We have already learned that volatility comes as an integral concept when trading not only currency pairs but also futures, stocks, bonds, etc. Traders may use it to quantify their potential risks and profitable opportunities. What’s more, price movements shape the market structure, which is sometimes hard to predict. With different technical tools such as standard deviation, it will be easier for traders to make accurate decisions.

When applying deviation to the Forex market, we need to take into account the fact that exchange rates may have three baseline foundations, that can be used to interpret and define standard deviation:

  • Low Levels depicts the market that has been in consolidation. This is where you have a chance to utilize rotating strategies and approaches, for example, reversion-to-the-mean.
  • Normal Levels depict the market in a stable position without unexpected or unpredictable movements. His is the most favorable situation for beginners who may utilize an array of trading strategies depending on their preferences. They can use pivot points, scalping, range trading, etc.
  • High Levels show the price volatility reaching an extreme level. It means that traders can benefit from higher potential rewards although with greater assumed risks because of high volatility and enhanced price action.

Each of the deviation levels comes with specific benefits and risks. You need to choose the one that meets your particular trading style and market-related objectives.

The Bottom Line

Active traders will definitely appreciate standard deviation as a handy mechanism and technical tool to improve financial decision-making. Besides, it is one of the most powerful technical indicators with intuitive reading and simple interpretation. It is available with all major trading platforms including MT4. To make it even more effective, you may implement it together with other tools such as STDEV or Bollinger Bands.

This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.