Understanding Indicators

Variance Explained

A statistical measure that measures the amount of variation or dispersion of a data set.

Jan 11, 2023

What is Variance?

The Variance is a statistical measure of the dispersion of a dataset. It is a measure of the volatility of an asset and is commonly used in technical analysis to identify potential trend changes and overbought and oversold conditions.


Calculation

The Variance is calculated as follows:


Var = ((Σ(xi - x̄)^2)/(n))


Where xi is each data point in the dataset, x̄ is the mean of the dataset, and n is the number of data points in the dataset.

In technical analysis, the Variance is typically calculated using the closing prices of an asset over a specified period, such as 14 days. The resulting value is then plotted on a chart as a line, with the mean being the centerline.


How is it Used?

The Variance is typically used to identify potential trend changes and overbought and oversold conditions. When the Variance is trending upwards, it indicates that the asset is becoming more volatile, which can be a signal of a potential trend change. When the Variance is trending downwards, it indicates that the asset is becoming less volatile, which can be a sign of a potential trend reversal.

In addition to identifying potential trend changes, the Variance can also be used to set stop-loss orders. For example, if the Variance is 2 and the current price is $100, a trader may set a stop-loss order at $96 ($100 - 2*2) to minimize potential losses.


The Pros & Cons of Variance


Pros

  • The Variance is a widely used and reliable indicator.

  • It is a simple and easy-to-use indicator that is suitable for beginners.

  • It can help traders identify potential trend changes and overbought and oversold conditions.

  • It can be used to set stop-loss orders to minimize potential losses.


Cons

  • It is a lagging indicator, meaning it is based on past price action and may not provide timely signals.

  • It may not be suitable for use in ranging or sideways markets.

  • The default settings for the Variance (14-period) may not work for all assets or market conditions.

  • It can be prone to false signals in choppy or volatile markets.

Indicator Pairings for Variance

  • Bollinger Bands: The Variance is often used to calculate the upper and lower bands in Bollinger Bands. Bollinger Bands are a technical analysis tool that consists of three lines plotted on a chart: the moving average, the upper band, and the lower band. The upper and lower bands are calculated as a certain number of standard deviations above and below the moving average, respectively.

  • Moving Average: The Variance can be used alongside a moving average to confirm potential trend changes. For example, if the Variance is trending upwards and the moving average is also trending upwards, it is a stronger bullish signal.

  • Average True Range (ATR): The ATR is a technical analysis indicator that measures the volatility of an asset. The Variance can be used in conjunction with the ATR to confirm potential trend changes.

  • Stochastic Oscillator: The Stochastic Oscillator is another popular momentum indicator that is used to identify potential trend reversals. It can be used alongside the Variance to confirm potential trend reversals.

  • Moving Average Convergence Divergence (MACD): The MACD is a trend-following indicator that is used to identify potential trend changes. It can be used alongside the Variance to confirm potential trend changes.


Things to Consider

  • It is important to use the Variance in conjunction with other technical analysis tools and indicators to confirm potential trend changes.

  • The default settings for the Variance (14-period) can be adjusted to suit the trader's preference.

  • It is important to use the Variance in the context of the overall market trend.

  • The Variance is typically plotted on the same chart as the price, but it can also be plotted on a separate axis.

In conclusion, the Variance is a useful technical analysis tool that can help traders identify potential trend changes and overbought and oversold conditions. While it has its pros and cons, it is important for traders to consider the nuances of using the indicator and to use it in conjunction with other technical analysis tools to confirm potential trend changes.

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