The Empirical Rule

and Z-Score
 What Is the Empirical Rule?

O The empirical rule, also referred to as the three-sigma rule

or 68-95-99.7 rule, is a statistical rule which states that for
a normal distribution almost all observed data will fall
within three standard deviations (denoted by σ) of the mean
or average (denoted by µ).
O In particular, the empirical rule predicts that 68% of
observations falls within the first standard deviation (µ ± σ),
95% within the first two standard deviations (µ ± 2σ), and
99.7% within the first three standard deviations (µ ± 3σ).
What Is a Normal Distribution?

ONormal distribution, is a
probability distribution that is
symmetric about the mean,
showing that data near the mean
are more frequent in occurrence
than data far from the mean.
 KEY TAKEAWAYS

1. The Empirical 2. Under this rule,

Rule states that 68% of the data
99.7% of dat falls within one
a observed standard deviation,
following a normal 95% percent within
two standard
distribution lies
deviations, and
within 3 standard 99.7% within three
deviations of the standard deviations
mean. from the mean.
3. Three-sigma
limits that follow
the empirical rule
are used to set the
upper and lower
control limits in
statistical quality
control charts and
in risk analysis such
as VaR( value-at-
risk).
 How to Use the Empirical Rule

O The empirical rule is used often in statistics for

forecasting final outcomes. After calculating the
standard deviation and before collecting exact data, this rule
can be used as a rough estimate of the outcome of the
impending data to be collected and analyzed.
Analysts use the empirical rule to predict the probabilities
and distributions of the outcomes that they’re studying. It’s a
valuable tool because it lets us make predictions using several
easy-to-calculate statistics. Verify that our data follow a normal
distribution at least roughly. If it does, you can start making
forecasts by calculating the mean and standard deviation.
O Many organizations use the empirical rule as a quality
control method because you can safely assume many
variables follow the normal distribution, and it’s easy
to calculate the mean and standard deviation.
Similarly, the value-at-risk (VaR) financial risk
assessment assumes that the probabilities for outcomes
follow a normal distribution. In short, the empirical
rule is a quick and easy prediction method that
provides good results.
 Empirical Rule Formula
(68 95 99 Rule)

O To calculate the data ranges associated with

the empirical rule percentages of 68%, 95%,
and 99.7%, start by calculating the sample
mean (x̅) and standard deviation (s). Then
input those values into the formulas below to
derive the ranges.
 Percentage of data in
Data range
the range

x̅ − s, x̅ + s 68%

x̅ − 2s, x̅ + 2s 95%

x̅ − 3s, x̅ + 3s 99.7%
These two data sets have the same mean (mu), but
different standard deviations (sigma).
 Example of
Using the
Empirical Rule
Assume that a pizza
restaurant has a
mean delivery time
of 30 minutes and a
standard deviation
of 5 minutes, and the
data follow the
normal distribution.
O Using the empirical rule, we can estimate the range in
which 68% of delivery times occur by taking the mean
and adding and subtracting the standard deviation (30
+/- 5), producing a range of 25-35 minutes.
O Use the same process for the other empirical rule
percentages by using the 2X and 3X multiples of the
standard deviation. 95% are between 20-40 minutes (30
+/- 2*5), and 99.7% are between 15-45 minutes (30 +/-
3*5). The chart below illustrates this property
graphically.
 What Is Z-Score?
O Z-score is a statistical measurement that describes a
value's relationship to the mean of a group of values. Z-
score is measured in terms of standard deviations from the
mean. If a Z-score is 0, it indicates that the data
point's score is identical to the mean score. A Z-
score of 1.0 would indicate a value that is one
standard deviation from the mean. Z-scores
may be positive or negative, with a positive
value indicating the score is above the mean and
a negative score indicating it is below the mean.
O How Is Z-Score Used in Real Life?
O A z-score is used in many real-life applications, such as medical
evaluations, test scoring, business decision-making, and investing and
trading opportunity measurements. Traders that use statistical measures
like z-scores to evaluate trading opportunities are called quant traders
(quantitative traders).
O What Is a Good Z-Score?
O The higher (or lower) a z-score is, the further away from the mean the
point is. This isn't necessarily good or bad; it merely shows where the
data lies in a normally distributed sample. This means it comes down to
preference when evaluating an investment or opportunity. For example,
some investors use a z-score range of -3.0 to 3.0 because 99.7% of
normally distributed data falls in this range, while others might use -1.5
to 1.5 because they prefer scores closer to the mean.
 KEY TAKEAWAYS
O A Z-Score is a statistical O In general, a Z-score of -
measurement of a 3.0 to 3.0 suggests that a
score's relationship to stock is trading within
the mean in a group of three standard deviations
scores. of its mean.
O A Z-score can reveal to O Traders have developed
a trader if a value is many methods that use z-
typical for a specified score to identify
correlations between
data set or if it is
trades, trading positions,
atypical.
and evaluate trading
strategies.
 Z-Score Formula
O The statistical formula for a value's z-score is
calculated using the following formula:

z=(x-μ)/σ
Where:
O z = Z-score
O x = the value being evaluated
O μ = the mean
O σ = the standard deviation