How Standard Deviation (Volatility) Estimate The Expected Price Movements ?

Introduction

Standard deviation is a statistical term that measures the amount of variability or dispersion around an average. Standard deviation is also a measure of volatility. Generally speaking, dispersion is the difference between the actual value and the average value. The larger this dispersion or variability is, the higher the standard deviation. The smaller this dispersion or variability is, the lower the standard deviation. Chartists can use the Standard Deviation to measure expected risk and determine the significance of certain price movements.

Calculation

We calculates the Standard Deviation for a Population, which assumes that the periods involved represent the whole data set, not a sample from a bigger data set. The calculation steps are as follows:

1. Calculate the average (mean) price for the number of periods or observations.
2. Determine each period's deviation (close less average price).
3. Square each period's deviation.
4. Sum the squared deviations.
5. Divide this sum by the number of observations.
6. The standard deviation is then equal to the square root of that number.

The spreadsheet above shows an example for a 10-period Standard Deviation using QQQQ data. Notice that the 10-period average is calculated after the 10th period and this average is applied to all 10 periods. Building a running standard deviation with this formula would be quite intensive. Excel has an easier way with the STDEVP formula. The table below shows the 10-period Standard Deviation using this formula. Here's an Excel Spreadsheet that shows the Standard Deviation calculations.

Standard Deviation Values

Standard Deviation values are dependent on the price of the under security. Securities with high prices, such as Google (±550), will have higher Standard Deviation values than securities with low prices, such as Intel (±22). These higher values are not a reflection of higher volatility, but rather a reflection of the actual price. Standard Deviation values are shown in terms that relate directly to the price of the underlying security. Historical Standard Deviation values will also be affected if a security experiences a large price change over a period of time. A security that moves from 10 to 50 will most likely have a higher Standard Deviation at 50 than at 10.

On the chart above, the left scale relates to the Standard Deviation. Google's Standard Deviation scale extends from 2.5 to 35, while the Intel range runs from .10 to .75. Average price changes (deviations) in Google range from $2.5 to $35, while average price changes (deviations) in Intel range from 10 cents to 75 cents.

Despite the range differences, chartists can visually assess volatility changes for each security. Volatility in Intel picked up from April to June as the Standard Deviation moved above .70 numerous times. Google experienced a surge in volatility in October as the Standard Deviation shot above 30. One would have to divide the Standard Deviation by the closing price to directly compare volatility for the two securities.

Measuring Expectations

The current value of the Standard Deviation can be used to estimate the importance of a move or set expectations. This assumes that price changes are normally distributed with a classic bell curve. Even though price changes for securities are not always normally distributed, chartists can still use normal distribution guidelines to gauge the significance of a price movement. In a normal distribution, 68% of the observations fall within one standard deviation. 95% of the observations fall within two standard deviations. 99.7% of the observations fall within three standard deviations. Using these guidelines, traders can estimate the significance of a price movement. A move greater than one standard deviation would show above average strength or weakness, depending on the direction of the move.

The chart above shows Microsoft (MSFT) with a 21-day Standard Deviation in the indicator window. There are around 21 trading days in a month and the monthly Standard Deviation was .88 on the last day. In a normal distribution, 68% of the 21 observations should show a price change less than 88 cents. 95% of the 21 observations should show a price change of less than 1.76 cents (2 x .88 or two standard deviations). 99.7% of the observations should show a price change of less than 2.64 (3 x .88 or three standard deviations. Price movements that were 1,2 or 3 standard deviations would be deemed noteworthy.

The 21-day Standard Deviation is still quite variable as it fluctuated between .32 and .88 from mid August until mid December. A 250-day moving average can be applied to smooth the indicator and find an average, which is around 68 cents. Price moves larger than 68 cents were greater than the 250-day SMA of the 23-day Standard Deviation. These above average price movements indicate heightened interest that could foreshadow a trend change or mark a breakout.

Conclusions

The Standard Deviation is a statistical measure of volatility. These values provide chartists with an estimate for expected price movements. Price moves greater than the Standard Deviation show above average strength or weakness. The Standard Deviation is also used with other indicators, such as Bollinger Bands. These bands are set 2 standard deviations above and below a moving average. Moves that exceed the bands are deemed significant enough to warrant attention. As with all indicators, the Standard Deviation should be used in conjunction with other analysis tools, such as momentum oscillators or chart patterns.

SharpCharts

The Standard Deviation is available as an indicator in SharpCharts with a default parameter of 10. This parameter can be changed according to analysis needs. Roughly speaking, 21 days equals one month, 63 days equals one quarter and 250 days equals one year. The Standard Deviation can also be used on weekly or monthly charts. 

How to Read an Annual Reports ?

Contents: non-audited information
• Narrative items
– Chairmen’s statement
– Directors’ report
– Operating and financial review
– Review of operations
– Statement of corporate governance
– Auditors report
– Statement of directors’ responsibilities for the financial statements
– Shareholder information
• Non-narrative
– Highlights
– Historical summary
– Shareholder analysis

Balance sheet
• A balance sheet is a statement of the resources owned and controlled by a business at a single point in time.
• It gives a snapshot of assets, liabilities and capital at a point in time.
• It provides information about the company’s funds and how they are used in the business.

Profit and loss account
• The Profit and Loss Account is a statement which shows total business revenue less expenses.
• The P&L account quantifies and explains the gains or losses of the company over the period of time bounded by two balance sheets
• It provides a summary of the year’s trading activities:
– Revenue from sales (turnover)
– Business costs
– Profit or (loss)
– How the profit was used.

Cash flow statement
• This is a statement which shows the flow of cash into and out of the business.
• It is not the same as a profit and loss account.
• The cash flow statement only records movements of cash and, for example, does not include credit sales or purchases until such time as cash actually flows.
• This statement became mandatory because of some high profile business failures of the 1980s/90s - these were companies that, in terms of the P&L, were profitable but were short of cash to pay their debts.
• The cash flow statement should not be confused with a cash flow forecast. The former is historical whereas the latter is a forecast about the future.
Statement of total recognised gains and losses
• The STRGL is a financial statement which attempts to highlight all shareholder gains and losses and not just those from trading.
• It is a summary of all the profits and losses made during the year.
• It is necessary because not all gains and losses are shown on the P and L account.
• Example: upward revaluation of a fixed asset is not classed as revenue from trading operations and so it will not shown up on the P and L Account. It does show up as an addition to revaluation reserves on the balance sheet

Notes to the accounts
• Provides a more detailed analysis of some of the entries in the accounts including:
• Disclosure of accounting policies used (e.g. depreciation) and any changes to these policies.
• An explanation for any deviation from accounting standards.
• Sources of turnover from different geographical areas.
• Details of fixed assets, investments, share capital, debentures and reserves.
• Directors emoluments (how much the Directors earned)
• Earnings per share

Accounting policies
• Companies must describe the accounting polices they use in preparing financial statements.
• Companies have a choice of accounting polices in many areas such as foreign currencies, goodwill, pensions, sales and stocks.
• As different accounting polices will result in different figures it is necessary to state the policy that was used so that readers of the accounts can make an informed judgement about performance.
• It is also important to state the effect of any changes in accounting policies – restating prior year numbers where this is materially significant

Chairpersons statement
• An overview of the trading year.
• A personalise overview of the company’s performance over the past year.
• Usually covers strategy, financial performance and future prospects.

Directors’ Report
• Its principal objective is to supplement the financial information with other information consider necessary for a full appreciation of the companies activities. It includes:
• A description of the principal activities of the company.
• A fair review of the current and future prospects of the business.
• Information on the sale, purchase or valuation of assets.
• Recommended dividends.
• Employee statistics.
• Names of directors and their interests.
• Details of political or charitable donations.

Operating and financial review
• This is a statement in the annual report which provides a formalised, structured explanation of financial performance.
• The operating review covers items such as operating results, profit and dividend.
• The financial review discusses items such as capital structure and treasury policy.
Operating and financial review

Operating review
• New product development
• Details of shareholders returns
• Risks and uncertainties
• Future investment
• Sensitivity of financial results to specific accounting policies

Financial review
• Current cash position.
• Sources of finding.
• Treasury policy.
• Capital structure.
• Confirmation of the business as a going concern.
• Factors outside the balance sheet impacting on the value of the business.
• Taxation.

Other features
• Highlights
– An “at a glance” summary of selected figures and ratios.
• Historical summary
– Five years of selected data from the balance sheet and profit and loss account
– Tables and graphs to illustrate trend and comparison of turnover, profit ,dividend and earnings per share.
• Shareholder analysis
– Detailed analysis of the shareholders, for example by size of shareholding

Auditors report
• Auditors are independent accountants who are registered to carry out this work.
• They also have to certify that the accounts are drawn up in accordance with the requirements of the Companies Act.
• Auditors must make a brief report to confirm that the accounts give a true and fair view of the firm’s financial position.

Prepared by CAMFinancialmarket

How Do We Know When To Sell Stock?

Often investors will sell their best stocks and hang on to their losers.  It’s human nature to try to avoid losses and by not selling a poor performing stock you can convince yourself you haven’t really lost anything – and if you hang on, it should bounce back, shouldn’t it?  Some people will sell if a stock really shoots up so they can take a profit.

So how do you know when to sell stocks, if ever?  Even die-hard buy-and-hold investors should watch for signs.

Buy and Hold means

The investment strategy of purchasing securities and holding them for extended periods of time. Investors using the buy-and-hold strategy select companies on the basis of their long-term outlook. Such investors are not influenced by short- or intermediate-term movements in the price of a security.

Set a Target Price

When you buy a stock, do some research and establish a realistic target for growth.  For example, you could set a target for a 50% increase in price.  When you have reached your target, follow through.  This is especially true with speculative stocks like junior mining companies.  Set a “sell-half” rule – when the stock doubles, sell half of your holdings. 

Sell Before You Buy

For every stock you add to your portfolio, sell one you already have.  This discipline forces you to review your holdings objectively and ferret out the losers.  This is an easy method to determine when to sell your stock.

Sell Your Stocks When the Market is Up, Not Down

While this sounds obvious, it’s usually against the pack.  Sell when everyone else is buying.  It sounds easy, but it’s tough to do.  Also, if several brokerages recommend a stock, it’s probably time to unload it.  The price always reflects popularity.

Monitor Even Your High Quality Stocks

Sometimes they can reach an unsustainable price level due to rumors, such as a take-over bid, but it can be anything.  If there is any question of lack of integrity within the company’s management, sell immediately.  If dividends are reduced or even eliminated, it may be the time to sell your stock.  Investigate the reason.

If you stick to stocks with a stable history of dividends and earnings you will become less inclined to sell.  Never sell simply on the basis of an unexpected price drop.  Revisit the reasons you bought the stock and if they are still valid, ride out the downturn.  Be disciplined and don’t get emotional.

The costs of selling – brokerage fees and capital gains tax – often outweigh the benefits, even if you are selling at a profit.

It’s always difficult to sell a stock.  If you didn’t believe in it, you wouldn’t have bought it in the first place.  Analyze your holdings.  Never let sentiment get in the way.  Make a thoughtful, rational decision when to sell your stock.

By CAMFinancialmarket