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

The average African-American admitted to UNC has combined SAT scores 200 points (on a 1,600-point scale) below those of the average admitted Asian-American student—over a standard deviation of difference. — Heather Mac Donald, WSJ, "Diversity Delusions at North Carolina," 10 Feb. 2019 The most extreme spikes—those 10 standard deviations above the mean or more—skewed even more positive. — Andrea Fuller, WSJ, "How Companies Secretly Boost Their Glassdoor Ratings," 22 Jan. 2019 The difference between tutoring and traditional instruction after just three weeks was two standard deviations—to researchers, a truly incredible result. — Matt Barnum, The Atlantic, "The Outdated Study That Education Reformers Keep Citing," 30 Jan. 2018 There are 10 measurements where 'Oumuamua was more than five standard deviations away from where it would be expected to have ended up based on gravity alone. — John Timmer, Ars Technica, "Visitor from another solar system accelerated away from the Sun," 28 June 2018 That may not sound like much, but for neutrinos, where detecting any of them is a serious challenge, that's enough to make for a 3.5 standard deviation excess. — John Timmer, Ars Technica, "Supermassive black hole shot a neutrino straight at Earth," 12 July 2018 For instance, start with the basics such as stocks and bonds before explaining sector diversification or standard deviation. — Veronica Dagher, WSJ, "The Problem When One Spouse Handles Finances," 21 Oct. 2018 The volatility of Brent crude, the international benchmark, has fallen to around 22%, measured by the standard deviation of daily price moves over the past year. — Sarah Mcfarlane, WSJ, "How OPEC and Shale Have Squeezed Out Volatility in the Oil Market," 1 June 2018 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

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

26 Apr 2019

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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