Definition
Standard deviation in finance measures the volatility of an asset's returns over a period. A higher standard deviation indicates greater price swings and thus higher risk. For normally distributed returns, approximately 68% of observations fall within one standard deviation of the mean, and 95% within two. Investors use standard deviation to assess risk and compare volatility across different investments. It's a key input in portfolio optimization and risk management.
Formula
Example
A stock with 15% average annual return and 20% standard deviation could reasonably return between -5% and 35% (one SD range) in any given year. Another stock with the same return but 40% SD has returns ranging from -25% to 55%.
FAQ
What is Standard Deviation?
A statistical measure of how dispersed returns are around the average.
How do you calculate Standard Deviation?
A common formula for Standard Deviation is: σ = √(Σ(xi - μ)² / n)
Why is Standard Deviation important?
Standard Deviation helps investors evaluate technical analysis and make more informed decisions.