Application of Standard Deviation

Standard Deviation is a measure to understand how much risk or spread is there in the data.
Standard deviation is measure of deviation or measure of variation on the basis of the values of
set data. Standard deviation has many business avenues such as follows:-
In business, standard deviation of price data are frequently used as a measure of volatility and
measure of risk involved.

• It is often used by investors to measure the risk of a stock or a stock portfolio and further it can
be used in making an investment decision.

• In manufacturing units it is used as a way of quality control.

• In polls and surveys it can be used to measure the level of confidence that can be achieved
through our result.

We can portray the use of standard deviation in the use of business of stocks.

Let’s us assume Mr. A has stocks of two companies Co. C and another Co. Z, Mr. A started
investing in the stocks of both the companies since past 10 years.

Year 1 2 3 4 5 6 7 8 9 10

Co. C 10% 4% 3% -15% -5% 8% 6% 7% 5% 7.5%

Co. Z -9% -15% -6% 3% 7% 8% 6% 9% 12% 18%

If we further calculate the mean of these two companies we can get the following results:-

Average of Co. C

= 10 + 4 + 3 + -15 + -5 + 8 + 6 + 7 + 5 + 7.5
=30.5/10 = 3.05%
Average of Co. Z
= -9 + - 15 + -6 + 3 + 7 + 8 + 6+ 9 +12 + 18
= 33 / 10 = 3.3%
Here as we can see that, the average of both the companies is almost same ie 3% we cannot
assure the investor which is the most safe investment. Hence during this dilemma the standard
deviation comes in for help.
The formula for Standard deviation is as follows:-

Where ,
σ = Lower case sigma is the symbol for standard deviation
Σ = Upper case sigma is the summation symbol
X = Each individual value in the data set
x̅ = The arithmetic mean (known as “x-bar”)
n = The number of data points in the set (the number of X values)

So using this formula we can calculate the deviation in the stocks of both the companies.
For Co . C mean is 3.05, N=10 X= 30.5

Year x
1 10
2 4
3 3
4 -15
5 -5
Therefore using the formula, SD for Co. C is 9.15
6 8
7 6
8 7
9 5
10 7.5
Sum of
return
30.5
for 10
yrs

For Co. Z mean is 3.3 ,N = 10, x = 33

 Year x Therefore using the formula , the SD of Co. Z is 9.9
1 -9
2 -15
3 -6
4 3
5 7
6 8
7 6
8 9
9 12
10 18
Sum of
return
33
for 10
yrs

Hence , as we saw SD of Co. C and Co. Z are as 9.15 and 9.9 respectively.
Standard deviation is a measure of risk, that an investment will not meet the expected in the
given period. The smaller an investment the lesser the risk, the less volatile (and hence risky) it
is. The larger the standard deviation, the more dispersed those returns are and thus the riskier the
investment is.

Hence from the above results we can conclude that the investment in stocks of Co. Z is more
risky than the investment in stocks of Co. C.