Now, we’re getting into some statistics, which is not my strong point. I understand the basics, but not much more than that.
Standard deviation (σ) is a measure of how volatile something it. It’s a measure of how far a value can be from the expected value (the mean μ). The easiest method to calculate the average is to take a list of historical prices (adjusted close prices) and calculate the average return from that.
First is to create a list of daily returns from the prices, and take the average of all the values in that array (N). The first value in the array is 1, because there is no change. You can download free adjusted close prices from Yahoo Finance (they’re adjusted for dividends and splits).
Once the average is calculated, you can calculate the standard deviation. The easiest method of calculating standard deviation is to use Excel or other programming language to do it, but you can do it manually as well.
The standard deviation is currently one of the best measures of risk for an investment. And you can calculate the standard deviation of a portfolio as well, just start with the daily returns of the portfolio instead of a specific investment.
Intuition about Values
The higher the standard deviation, the more the investment varies from the average return, and the more risk an investor would take on.
In general, the larger the average return, the larger the standard deviation should be, because no one wants to take larger risk for lower return.
Disclaimer: I’m writing these posts as a way to solidify my understanding of class materials, they may not be completely correct – and I welcome any corrections.