Standard deviation

Standard deviation is still the most widely used measure of dispersion, or in financial markets, risk.

Standard deviation (SD) is still the most widely used measure of dispersion, or in financial markets, risk.That all sounds a bit technical but it's actually pretty straightforward to understand.

It is based on the idea that any population is "normally distributed" in other words, whether it contains the height of every UK adult female, or the annual return from the FTSE 100 over 100 years, most members of a given group will be bunched around the arithmetic average for the whole group.

For the heights example, this would be the sum of every woman's height divided by the number of women in the UK. So a randomly chosen woman in the UK will on average be close to say 5'5" with only a few people significantly above or below that "mean" height (so-called "outliers").

SD quantifies the average dispersion of, say, heights or equity returns, above or below the mean figure. In other words, it's a measure of how widely the data varies from the mean.Given a normal distribution, about two-thirds of all the data points in a set should lie with one SD of the mean, and almost 100% should lie within three SD.

The higher the SD, the wider the spread of the data or the greater the risk that a randomly chosen woman from your data set is nowhere near the average of 5'5", or that the return from equities next year is way above or below the past 100-year average.

Recommended

Modern monetary theory (MMT)
Glossary

Modern monetary theory (MMT)

Modern Monetary theory, or MMT, has become popular on the left, both in the UK and abroad. (Wags say that it stands for "magic money tree".) 
21 Sep 2020
Price to sales ratio
Glossary

Price to sales ratio

A company's market cap divided by the company's annual sales (or revenue) gives us the price/sales ratio.
28 Aug 2020
Too embarrassed to ask: what is a p/e ratio?
Too embarrassed to ask

Too embarrassed to ask: what is a p/e ratio?

Find out how to use the price/earnings ratio (p/e ratio for short) – a useful starting place for investors looking to value a company.
26 Aug 2020
Stock split
Glossary

Stock split

A stock split increases the number of a corporation's issued shares by dividing each existing share.
21 Aug 2020

Most Popular

This week’s rally in value stocks is just the beginning
Value investing

This week’s rally in value stocks is just the beginning

The arrival of a vaccine this week saw huge gains in the markets and investors switching out of big-tech growth stocks and into “value” stocks in more…
13 Nov 2020
Share tips of the week
Share tips

Share tips of the week

MoneyWeek’s comprehensive guide to the best of this week’s share tips from the rest of the UK's financial pages.
13 Nov 2020
Time for investors to be fearful, not greedy – and sell?
Investment strategy

Time for investors to be fearful, not greedy – and sell?

The Covid-19 crash proved a great investment opportunity. Does the vaccine mean it’s time to sell?
23 Nov 2020