The technical indicator Standard Deviation is used to determine the width of deviations and price changes of a currency pair. Translated from the original language, the indicator name means “standard deviation”. This tool is used in a considerable number of profitable trading systems as a measure of asset volatility and to find the most profitable and correct entry points to the market. Let’s take a closer look at its basics, methods of application and settings.
Description of how Standard Deviation works
Standard Deviation searches for the level of price deviation from the average for a given time interval. In simpler terms, it shows how much the price indicators change from their static movement. The deviation level on the chart is marked with an “O” symbol and marks the asset’s volatility level. When the data from the Standard Deviation indicator becomes higher, the market becomes more volatile and the boundaries of price changes become wider.
Application of the indicator
The tool is recommended to be used in combination with different indicators in search of a successful and profitable combination. For example, you can use it in tandem with the X-Lines indicator, which we already wrote about earlier, and thus determine important price levels. The best situations to open profitable trades will be when the price approaches important levels and the standard deviation indicator rises above the average.
The considered indicator can be used not only as a source of signals for entering the market, but also as a tool for medium and long-term trading. It is often used by investors as an effective way to find stocks or valuable assets to build a trading portfolio. With the help of Standard Deviation, the levels of profit and risk are calculated when investing in assets.
What is the indicator calculation formula? If we simplify the original formula, Standard Deviation indicates the amount of deviations of the current quote from the moving line, which smoothes the readings from the chart.
The indicator is visually represented as a broken curve in the basement of the working graph. If the value of the curve becomes higher, it means that the volatility of the stock or working asset has increased more. If the line, on the contrary, goes down, lower, it means that volatility has dropped.
How to install the Standard Deviation indicator?
The indicator can be used to work in any trading markets, and even when concluding transactions with binary options. It is not a standard tool in the Metatrader 4 trading terminal; you need to download and install it separately.
To download Standard Deviation follow this link.
After downloading the archive with the indicator, unpack its contents to a convenient place for you and you can proceed with the installation:
- Launch the trading terminal Metatrader 4.
- In the drop-down menu select “File” – “Open data directory”, or use the key combination Ctrl + Shift + D.
- A new window will open in front of you, in which you need to open the “Indicators” folder. Transfer into it what was compressed in the archive.
- Update the data in the trading terminal.
To add an instrument to the chart, go to the “Indicators” category in the drop-down menu, or drag it with the mouse held down to the workspace from the “Navigator” section. Now that the Standard Deviation indicator has appeared in the working window, you can proceed to its settings.
The setting of the indicator parameters resembles the settings of the usual MA. The main function will be to set the period – it depends on how sensitive the instrument will be to price fluctuations. It is equal to “20” by default.
In addition, in the parameters you can change the type of quotes used for calculation. To change it, use the “Apply to …” function. The “Close” function, set by default, calculates the closing quotes. You can also choose “Open”, “High” or “Low”.
The MA Type function sets up the type of moving average, which is the basis for determining the price deviation. MA “Simple” is used as an initial parameter, that is, a simple moving average line. The color and style of the curved line is also adjustable.
The dynamics of the price of each asset in the market consists of periods of a protracted trend movement and a lull in the form of a short flat, which replace each other. The Standard Deviation indicator does a good job of identifying this market pattern.
When the SD line is in the “0” level zone, it tells us about the flat state in the market. Conversely, the more the standard deviation curve approaches the “100” level, the more and more the asset’s volatility increases. The indicator is also used when opening trading sessions in MetaTrader 4. The stronger the deviations, the more volatile the price movement will be.
However, it should be borne in mind that these price fluctuations will not necessarily give a correct forecast of the further market movement. They are often impulsive and are market noise or active but short-term activity of market makers. For this reason, the standard deviation indicator is recommended to be applied as an additional filter to the main instruments of your trading strategy.
The main key to using the indicator on Forex lies in finding profitable entry points to the market within the current trend. The chain of actions is quite simple: first, using any trend indicator, we fix the direction of price movement. Then we wait for the moment when the Standard Deviation line reaches the highest or lowest value and enter the market with a buy or sell deal. For example:
- We observe a continuous upward movement. The price starts going into a pullback, enters a correction or consolidation, and the indicator curve reaches its peak. This will be a buy signal.
- The chart shows a prolonged downward movement, the price enters a correction in the direction opposite to the main trend. The indicator is approaching one of the extreme boundaries “0” or “100”. This will be a signal to sell.
Based on the above, we can see that the main principle of using Standard Deviation is to trade at the moments when the instrument’s curve approaches its extreme values. You should only trade in the direction of the main trend. Remember, the trend is your friend!
We recommend that you familiarize yourself with a few simple and effective forex trending strategies.
The main disadvantage when trading according to Standard Deviation is erroneous signals of the instrument at the moments when the curve is delayed at one of the extreme zones. As a rule, this happens at a time when the market is in a long consolidation. For such situations, it is necessary to use auxiliary indicators as filters. The most common way to filter out false signals is to add MAs with large periods to the chart. Do not forget to increase the calculation of the period directly in the indicator. As a result, you will have an independent trading strategy. It is worth entering the market only at such moments when the signals of the MA and the instrument coincide.
Filtering with RSI
One way to avoid false signals is to use the RSI. In its parameters, you need to add an auxiliary level “50”, and in addition, disable the function “fix the lows, fix the highs”. Set the period of the curve to “5” bars.
Examples of trading situations:
- Upward movement. RSI is in the oversold zone, and Standard Deviation has reached its extreme value. This will be a signal to buy.
- Downward movement. RSI is in the overbought zone, and Standard Deviation has reached its extreme value. This will be a signal to sell.
This method will help you enter a trade during the inception of a trend, when a new movement is only gaining strength.
You can also use another tool to filter signals – the RSI Alert indicator. This is a standard RSI supplemented by a convenient alert function.
Bollinger Bands Filtering
Another good way to filter out losing trades is the Bollinger bands indicator located in the terminal by default. It consists of three MAs, which are presented as a price channel. The extreme moving ones are the channel boundaries and conditional overbought and oversold levels. The central moving average duplicates the main market movement.
Trades must be opened at the moment when the price approaches the extreme boundaries of the Bollinger bands, and the Standard Deviation indicator tends to the “100” level. Login examples:
- If the price approached the lower Bollinger band, it will be a buy signal.
- When the price reaches the upper Bollinger band, it will be a sell signal.
Trades should be closed when the standard deviation indicator begins to approach the “0” level, or if the price reaches the opposite side of the Bollinger Bands.
The Standard Deviation indicator is a universal tool for technical analysis of price movements. It does not generate trading signals and does not indicate the direction of movement. Its main task is to show the level of asset volatility and the strength of the trend trend.
Watch an additional video on the topic of the publication – Variants of using the Standard Deviation indicator to find the standard deviation