In Step Two, you take each of the 12 returns and then subtract the average

from it. This shows how much any one return differs from the average, to
give you a sense of how much the returns can go back and forth.
In Step Three, you take each of those differences and then square them
(multiply them by themselves). This gets rid of the negative numbers. When
you add those up, you get a number known in statistics as the sum of the
squares.
Now you have enough for Step Four: taking the average of the sum of the
squares.
And for Step Five: the square root of the average of the sum of the squares.
That square root from Step Five is the standard deviation, the magic number
were looking for.
Of course, you dont have to do all of this math. Almost all trading software
calculates standard deviation automatically, but at least you now know where
the calculation comes from.
Calculating Standard Deviation
Step One:
Find the expected return
Step Two:
Subtract expected return
from each reported return
Step Three:
Calculate the square
of each difference
Percentage
Return R-E(R) (R-E(R))^2
January (0.02) (0.0211) 0.0004
February 0.01 0.0079 0.0001
March (0.00) (0.0040) 0.0000
April 0.09 0.0849 0.0072
May 0.01 0.0082 0.0001
June 0.01 0.0082 0.0001
July (0.08) (0.0818) 0.0067
August 0.02 0.0182 0.0003
September 0.03 0.0282 0.0008
October (0.04) (0.0418) 0.0017
November (0.01) (0.0118) 0.0001
December 0.01 0.0049 0.0000
0.02
Sum of the squares:
Average of the sum of the squares
Square root of the average of the
sum of the squares, also known as
standard deviation
0.0176
E(R)
Total
0.0018 Step Four: 0.0015
Step Five:
0.0383
Figure 11-11:
Calculating
standard
deviation.
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Chapter 11: But Did You Make Money? Evaluating Performance
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