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Standard Deviation is another thing that has no place in trading. Not even when used with VWAP. Standard Deviation describes the expected deviation of a normal distribution, but there is nothing in trading that follows a normal distribution, be it price changes or volume. It's another idea that somebody has just taken because it has a meaning in another domain, but is has no meaning in trading. |
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Perhaps this is the place for me to jump in here and clarify some concepts which are being used in some cases with confusion.
Standard Deviation (SD) is a well defined statistical concept for most distributions.
IT HAS NOTHING TO DO WITH WHETHER THE DISTRIBUTION IS NORMAL OR NOT. You can always define and therefore compute the standard deviation of a given set of price data. If you compute it with respect to the
VWAP, then the
SD so computed will be the smallest
SD for the given set of data as I have pointed out in
"Trading with Market Statistics. IV".
Where there is confusion is trying to relate the
SD to some percentage of the days price data. It will be 68.2% of the data provided the price data follows a Normal distribution. On most days this is not the case. As Sparrow has pointed out in this
thread, you then have to use Chebyshev's inequality to determine the percentages.
That being said, what can you do with this information. Well if you are a Market Profiler, you can always define the 70% data points and call this the
value area and then develop a trading strategy around this just as long as you realize that on most days this 70% value is not a standard deviation.
My preference of course has been to develop trading strategies based on the
VWAP and it's
SD's. The advantage of this is the
SD is an exact measure of market volatility. It tells you how far you can expect the price action to move from any given price point. It does not tell you of course which way that will be. I have pointed out however that the
SD points appear to be places where price action tends to stall or hold up and I have called these
HUP points, places where the market tends to have some indecision as to whether to reverse or continue on in the same direction.