Let’s start by defining what Standard Deviation is. Relative deviation is a statistical term that indicates the deviation of a statistical normal curve from the mean curve, or normal curve. So if we take the log of all the deviation cases then we have what is known as deviation of the arithmetic mean. This gives us deviation of the average. Now you may be asking what does relative standard deviation mean to you.
Relative deviation measures the standard deviation of the mean. This means that when the deviation occurs in one direction it can be considered as being in the mean or in the deviations and therefore this deviation makes the data normal. When the deviation occurs in the other direction it can be said to be against the mean and this deviation can then be considered to be abnormal. Now you may be asking why standard deviation is used at all.
Standard deviation is used because it gives us some tools that we can use to measure volatility. One tool is to see what happens to a portfolio when we remove the risk-takers from the portfolio. If you take your savings and invest it in money market accounts you will get a more accurate measurement of what the volatility is for the money because you are removing the risk-takers from the portfolio. If you remove from the portfolio the investment that has the highest volatility then what you are left with is the Standard deviation which will give you an idea of what does relative standard deviation mean. Relative standard deviation is basically the standard deviation of the mean.
Now you know what Standard deviation is and you also know what Standard deviation is not so what does relative deviation mean. Relative deviation actually is what caused the Standard deviation to be introduced into the Standard mean. Now what happens when Standard deviation is introduced into the investment portfolio is that Standard deviation causes prices to spread out from the mean. This spreads the risk over a greater period of time.
As the Standard deviation increases with time you start seeing an increased amount of price swings in any investment portfolio. The risk-taker moves towards or away from any investment strategy. The price volatility in any investment increases because the risk-taker is shifting from one strategy to another. As the Standard deviation increases with time it causes the mean to deviate from what it should be. This deviation in the mean causes an asset’s value to go up or down, depending on what strategy the risk-taker is using. Now what does relative standard deviation mean to an investor?
Well relative standard deviation measures volatility in an investment portfolio by subtracting the mean from the deviation and calculating the range that it might go to. The higher the deviation is the larger the range and therefore the bigger the potential swing in any investment. An investor uses Standard deviation to determine whether to go long or short, whether to use a momentum buy or hold strategy and if it’s a good time to add a trading strategy to their portfolio. So what does relative standard deviation do for you? It tells you if your investment portfolio is over exposed or under exposed. You may want to add or drop a part of your portfolio depending on how it measures the risk-taker’s deviation from the mean.