Trader Tip: Standard Deviation In our ever quest to search for new ideas to develop our trading strategies, here may be an idea that is of interest to you – standard deviation. A standard deviation “price derived” indicator can sense strong price moves from the current market mean prices, and comes as a standard indicator on the MT4 trade platform. The question is, when you see a big move (a high price standard deviation), how can we use this to build a potential Trade Plan around this market dynamic? Now, don’t let the math formula scare you. We can trust the mathematics within the MT4 indicator. What we need to be able to do is understand what we can do with the data calculated and apply it to our trading. In this Trader Tip we shall discuss how standard deviation might be useful in our Trade Plans to build a more successful systematic and repeatable approach in our trading.
By way of review, Standard Deviation in statistics (SD, also represented by the Greek letter sigma σ or the Latin letter s) is a measure that is used to quantify the amount of variation or dispersion of a set of data values. A low standard deviation indicates that the data points tend to be close to the mean (also called the expected value) of the set, while a high standard deviation indicates that the data points are spread out over a wider range of values.
Getting into the details of this concept, we first might want to set up the chart and apply a moving average (MA) and the standard deviation (StdDev) indicators to a chart instrument. We then estimate the base within the standard deviation indicator (market lulls) and then what a high standard deviation might be (the price spike out of the ordinary). From this, we will want to identify two points in the time series. The first, where the price spike occurred (marked in brown in the below examples), and the second when the price spike has subsided (marked in orange in the below examples). The strategy idea is that when a price spike occurs, this is signalling potential follow on price moves (trend) that we will want to exploit. By way of example let’s go through a couple of examples to identify potential Trigger areas (first a good example and then a bad example that should be Filtered as a potential trade).
In this first example (click image to enlarge), after identifying the step up at the orange line, we are looking for three things to make this a potential “good” trade. First is the slope of the MA, is it moving reasonable in your trade direction? Then has price, made an opposing swing high/low from where the price spike (brown line) has occurred. Finally, did the price spike standard deviation occur due to the direction of the MA? If all are true, this would indicate that the trend will continue in the direction of the MA and one could trade accordingly.
In this second example (click image to enlarge), we see our set up has not been satisfied. The slope of the MA is flat. Price has made an opposing new swing high/low point. And finally the price spike created a standard deviation against the MA. Hence this trade set up would be avoided. Remember this is not a 100% sure Trigger, but a “good” trader only has to be 50% correct, if one has a PSR (profit stop ratio of 2 to 1). Even the “best” traders only have about a 60% win rate – anyone telling you differently is either not profitable or less than honest. You must play the averages.
We have not discussed much about the actual Trade Plan, I will let you do this. Rather we are pointing out the Trade Plan set up to identify potential Trigger areas, where the further actual Trigger can be defined at a lower level, in conjunction with the other parts to the Trade Plan (i.e. Stops, Targets, etc…). In the examples we have used a 4-hour chart, with a standard deviation of 10, and a moving average of 50. However, you may want to play around with these settings and time series to refine it further, when constructing your Trade Plan(s). Click here, or watch below a video presentation of this Trader Tip.
Proudly powered by: