Skewness and Kurtosis
By Ernie Varitimos
April 1, 2022
0:00 / 8:33
Skewness and Kurtosis

Okay. 3, 2, 1.

How are you doing friends? Ernie here. And this is the Zero Days to Expiration podcast.

This is episode number 87. And what I wanted to talk about was asymmetric distributions, or let's back up and say, what I really wanted to talk about is the difference between asymmetric distributions and normal distributions.

Now, one of the problems with trading is that everyone bases their models on a normal distribution model, which means that there is an equal number of wins and losses are about the mean, and they make their predictions based on that kind of distribution of prices or events or things that might happen.

If you do that. And if in fact the market does provide a normal distribution of events, you'd never win anything because you would have an equal number of wins and losses and sizes of wins and losses about the mean. So it makes no sense. And that's in fact, what our trading platforms are showing us too.

And most of the calculations are based on a normal distribution, and this makes no sense because the market is anything, but normal. It is asymmetric. Now what is an asymmetric distribution? An asymmetric distribution is one where you have something called fat tails, another thing called skew and kurtosis.

Now, these are really weird names. Skewness kurtosis and fat tails. So what that means is that describes the shape of the distribution. Now, normally it looks like a bell, a little bell, right? Like a big bell and flare it out a rim of the bell and the very middle of that graph right at the. The peak, highest point of the bell is what we would call the mean or the average price.

And typically the average price has most of the population of results are either to the left or to the right of that mean. In an asymmetric distribution, they are either more to the left or more to the right. To the right as meaning positive. In other words, those were all the winners and to the left, meaning negative.

Then what we would want is we would want a large number of small losses. So we would want a little bit of the height or the kurtosis Al I'll explain that in a little bit on the left side and then a long tail. What's called the fat tail. And if possible, make it nice and fat, not too thin, but nice and fat and long so that we have a lot of big winners.

ErnieDub

So that would be a positive asymmetry. Now, the amount of lean that it has from one side to the other, or the amount of tail on one side and lack of tail on the other is the skewness. And so something that has a long tail on the positive side is considered a positive skew and something that has a long tail and less, or a lot of small wins on that would be a negative skew.