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CandleFocus Glossary Editor
The Arithmetic Mean is a basic form of statistical calculation that is commonly used to generate a single figure representing multiple values. It is also known as the “average” of a set of numbers, or the “mean” of the values. To calculate the Arithmetic Mean, you take the sum of numbers in the set and divide by the number of elements in that set.
As an example, if the set consists of 4, 8, 10 and 12 than the Arithmetic Mean would be (4 + 8 + 10 + 12) / 4 = 9. To put in simpler words, the Arithmetic Mean is the sum of all numbers in the set divided by the quantity of numbers.
In the world of finance, the Arithmetic Mean is not usually an appropriate method for calculating an average due to the influence of outliers. These outliers can skew the mean by a large amount, providing a false indication of the performance of the underlying asset. In this situation, it requires the assistance of more appropriate averages, such as the Geometric Mean or the Harmonic Mean, to get a realistic indication of the market price.
The Geometric Mean is calculated by finding the product of all terms in the series then finding the nth root, where n is the total number of elements. It is used to measure the growth in a set of values when the initial investment is of a larger sum in comparison to subsequent investments. Meanwhile, the Harmonic Mean is used to calculate an average of data points when the size of the individual points does not necessarily reflect their importance. This is also known as the “inverse” of the arithmetic mean, which generally tends to overestimate the average of any given set of numbers.
In conclusion, it is important to keep in mind that while the Arithmetic Mean is a straightforward way of calculating a single figure from a set of values, it is mainly suited to situations in which there is limited risk or the outliers are minimal, as the extra figures can skew the actual outcome of the calculations. When this is not the case, it is preferable to use either the Geometric or Harmonic Mean to ensure that the figures are as realistic as intended.
As an example, if the set consists of 4, 8, 10 and 12 than the Arithmetic Mean would be (4 + 8 + 10 + 12) / 4 = 9. To put in simpler words, the Arithmetic Mean is the sum of all numbers in the set divided by the quantity of numbers.
In the world of finance, the Arithmetic Mean is not usually an appropriate method for calculating an average due to the influence of outliers. These outliers can skew the mean by a large amount, providing a false indication of the performance of the underlying asset. In this situation, it requires the assistance of more appropriate averages, such as the Geometric Mean or the Harmonic Mean, to get a realistic indication of the market price.
The Geometric Mean is calculated by finding the product of all terms in the series then finding the nth root, where n is the total number of elements. It is used to measure the growth in a set of values when the initial investment is of a larger sum in comparison to subsequent investments. Meanwhile, the Harmonic Mean is used to calculate an average of data points when the size of the individual points does not necessarily reflect their importance. This is also known as the “inverse” of the arithmetic mean, which generally tends to overestimate the average of any given set of numbers.
In conclusion, it is important to keep in mind that while the Arithmetic Mean is a straightforward way of calculating a single figure from a set of values, it is mainly suited to situations in which there is limited risk or the outliers are minimal, as the extra figures can skew the actual outcome of the calculations. When this is not the case, it is preferable to use either the Geometric or Harmonic Mean to ensure that the figures are as realistic as intended.