When examining the value of stocks, downside deviation is an amount that is less than the minimum accepted return, or MAR. Unlike standard deviation, which looks at the difference, positive and negative, from a mean or average, downside deviation only looks at the negative. The MAR of a stock is the amount an investor hopes to earn from it each year. For example, an MAR can be 2 percent or it can be 10 percent.
Look at the return over a series of periods. For example, you can look at the return on the stock over a period of 12 months or over a period of five years. Record the return for each period on the paper.
Determine the MAR. You can set this rate yourself based on the amount of risk in your investments. For example, use a rate of 1 percent as the MAR.
Deduct the MAR from the return for each period. If the return for month 1 was zero, you will end up with -1 after you subtract the MAR from the return. If you end up with a positive number for any period, use 0 in your calculations. For example, if the return for month 5 is 3, the value to use for that period is 0.
Square each of the values. For example, for month 1, -1 squared gives you 1. For month 5, 0 squared is 0. After you have the square of each value, add them together.
Divide the sum of the values by the number of periods. For example, if you are working with 12 periods, divide the sum by 12.
Find the square root of the value from Step 5. Unless you end up with an easy number, such as 4 or 9, you may want to use a calculator to determine the square root. The result is the downside deviation.
Items you will need
- Paper and pencil