Kurtosis: A Beginner’s Guide to Trading
Traders and investors use kurtosis to analyze probability distributions. It helps analyze distribution tails to assess trading strategy and investment risk and profit.
Kurtosis evaluates how far a distribution deviates from the bell curve (normal distribution). It indicates if the data has heavy tails or abrupt peaks, suggesting a greater or lower chance of extreme occurrences than a normal distribution.
Kurtosis may assist traders predict market changes and assess investment risk and return.
Kurtosis types
There are three basic forms of kurtosis traders should know:
Mesokurtic Distribution: Like the normal distribution, this distribution has zero kurtosis. Tail distribution is balanced and tails are neither heavy nor light.
Leptokurtic Distribution: Unlike the normal distribution, a leptokurtic distribution features thick tails and a steeper peak. Extreme events and volatility are more probable.
A platykurtic distribution has lighter tails and a flatter peak than a normal distribution since its negative kurtosis value is below 0. This implies less volatility and dramatic incidents.
Trading Kurtosis Interpretation
Kurtosis can illuminate market dynamics, risk management, and trading strategy performance.
A greater kurtosis rating indicates more dramatic market occurrences and riskier investments. Market participants may need to alter stop losses and position size to limit risk.
A lower kurtosis score suggests a lesser risk of severe occurrences, making it a safer investment. To make educated trading judgments, various statistical metrics and market circumstances must be considered.
Kurtosis may also evaluate trading strategies. A non-random pattern or edge may exist if the method regularly provides results that differ considerably from a normal distribution.
Conclusion
Traders and investors need kurtosis to understand probability distributions. By studying kurtosis, traders may predict extreme market occurrences, alter risk management measures, and evaluate trading tactics.
References:
https://en.wikipedia.org/wiki/Kurtosis