The simple definition of the term variance is the spread between numbers in a data set. Variance is a statistical measurement used to determine how far each number is from the mean and from every other number in the set. You can calculate the variance by taking the difference between each point and the mean. Then square and average the results.
Standard deviation measures how data is dispersed relative to its mean and is calculated as the square root of its variance. The further the data points are, the higher the deviation. Closer data points mean a lower deviation. In finance, standard deviation calculates risk so riskier assets have a higher deviation while safer bets come with a lower standard deviation.
Investors use variance to assess the risk or volatility associated with assets by comparing their performance within a portfolio to the mean. For instance, you can use the variance in your portfolio to measure the returns of your stocks. This is done by calculating the standard deviation of individual assets within your portfolio as well as the correlation of the securities you hold.
The variance of an asset may not be a reliable metric. Calculating variance can be fairly lengthy and time-consuming, especially when there are many data points involved. Variance doesn’t account for surprise events that can eat away at returns. And variance is often hard to use in a practical sense not only is it a squared value, so are the individual data points involved.
The standard deviation and variance are two different mathematical concepts that are both closely related. The variance is needed to calculate the standard deviation. These numbers help traders and investors determine the volatility of an investment and therefore allows them to make educated trading decisions.