standard deviation

noun

Definition of standard deviation

1 : a measure of the dispersion of a frequency distribution that is the square root of the arithmetic mean of the squares of the deviation of each of the class frequencies from the arithmetic mean of the frequency distribution also : a similar quantity found by dividing by one less than the number of squares in the sum of squares instead of taking the arithmetic mean

2 : a parameter that indicates the way in which a probability function or a probability density function is centered around its mean and that is equal to the square root of the moment in which the deviation from the mean is squared

Examples of standard deviation in a Sentence

Recent Examples on the Web

So often bench players carry higher standard deviations on performance because their minutes fluctuate more than starters. — Doug Norrie, SI.com, "NBA DFS Picks for February 12," 12 Feb. 2018 Another 25 locations are more than three standard deviations off. — John Timmer, Ars Technica, "Visitor from another solar system accelerated away from the Sun," 28 June 2018 The standard deviation on that statistic from round to round for all players in 2017 was 1.6 strokes, according to Mark Broadie, the Columbia University business professor who created the metric. — Brian Costa, WSJ, "Even for Jordan Spieth, Putting Is a Fickle Skill," 13 June 2018 The MiniBooNE result had a standard deviation measured at 4.8 sigma, just shy of the 5.0 threshold physicists look for. — NBC News, "A major physics experiment just detected a particle that shouldn't exist," 3 June 2018 Getting that to the point where the difference is five standard deviations—a value that physics accepts as indicating an effect is real—requires cutting down on those errors. — John Timmer, Ars Technica, "How long can a neutron survive outside an atom?," 14 May 2018 In 1986 the late paleontologist Stephen Jay Gould, a polymath himself, famously said that .400 hitters were disappearing because the standard deviation of talent was shrinking as the player pool grew larger and more skilled. — Tom Verducci, SI.com, "It's Not To Early to Call the Breathtaking Shohei Ohtani a Big League Phenomenon," 17 Apr. 2018 The research team found that each one standard deviation increase in handgrip strength was associated with an increase in stroke volume, an increase in end-diastolic volume and a decrease in left ventricular mass. — Mark Lieber, CNN, "A strong handshake could indicate a healthy heart," 14 Mar. 2018 For example, the researchers looked at patents from examiners whose average change in patent claim length was one standard deviation below average—suggesting that the claims in these patents had received below-average scrutiny. — Timothy B. Lee, Ars Technica, "Why the roots of patent trolling may be in the patent office," 5 Mar. 2018

These example sentences are selected automatically from various online news sources to reflect current usage of the word 'standard deviation.' Views expressed in the examples do not represent the opinion of Merriam-Webster or its editors. Send us feedback.

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Last Updated

11 Aug 2018

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standard deviation

noun

Financial Definition of standard deviation

What It Is

Standard deviation is a measure of how much an investment's returns can vary from its average return. It is a measure of volatility and in turn, risk. The formula for standard deviation is:

Standard Deviation = [1/n * (r_i - r_ave)²]^½

where:
r_i = actual rate of return
r_ave = average rate of return
n = number of time periods

For math-oriented readers, standard deviation is the square root of the variance.

How It Works

Let's assume that you invest in Company XYZ stock, which has returned an average 10% per year for the last 10 years. How risky is this stock compared to, say, Company ABC stock? To answer this, let's first take a closer look at the year-by-year returns that compose that average:

At first look, we can see that the average return for both stocks over the last 10 years was indeed 10%. But let's look in a different way at how close XYZ's returns in any given year were to the average 10%:

As you can see, only during year 9 did XYZ return the average 10%. In the other years, the return was higher or lower -- sometimes much higher (as in year 7) or much lower (as in year 2). Now look at the annual returns on Company ABC stock, which also had a 10% average return for the last 10 years:

As you can see, Company ABC also averaged 10% return over 10 years but did so with far less variance than Company XYZ. Its returns are more tightly clustered around that 10% average. Thus, we can say that Company XYZ is more volatile than Company ABC stock. Standard deviation seeks to measure this volatility by calculating how "far away" the returns tend to be from the average over time.

For instance, let's calculate the standard deviation for Company XYZ stock. Using the formula above, we first subtract each year's actual return from the average return, then square those differences (that is, multiply each difference by itself):

Next, we add up column D (the total is 3,850). We divide that number by the number of time periods minus one (10-1=9; this is called the "nonbiased" approach and it is important to remember that some calculate standard deviation using all time periods -- 10 in this case rather than 9). Then we take the square root of the result. It looks like this:

Standard deviation = √(3,850/9) = √427.78 = 0.2068

Using the same process, we can calculate that the standard deviation for the less volatile Company ABC stock is a much lower 0.0129.

Why It Matters

Standard deviation is a measure of risk that an investment will not meet the expected return in a given period. The smaller an investment's standard deviation, the less volatile (and hence risky) it is. The larger the standard deviation, the more dispersed those returns are and thus the riskier the investment is.

Many technical indicators, such as Bollinger Bands, incorporate the notion of standard deviation as a way to determine whether to buy or sell a stock, but it is important to remember that standard deviation is only one of many measures of risk and should not be the last word in deciding whether a stock is "too risky" or "not risky enough."

Source: Investing Answers