Three-Sigma Limits

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Definition of 'Three-Sigma Limits'

Three-sigma limits are a statistical concept used to measure the probability of an event occurring. In finance, they are often used to set risk limits for investments.

The three-sigma rule states that there is a 99.7% probability that an event will occur within three standard deviations of the mean. This means that there is a 0.3% chance that the event will occur outside of this range.

In finance, three-sigma limits are often used to set risk limits for investments. For example, a portfolio manager might set a limit of three standard deviations below the mean return for the portfolio. This means that the portfolio manager is willing to accept a 0.3% chance that the portfolio will lose money.

Three-sigma limits can also be used to set stop-loss orders for investments. A stop-loss order is a trade order that is placed to sell an investment if it falls below a certain price. By setting a stop-loss order, an investor can limit their losses if the investment price falls sharply.

Three-sigma limits are a useful tool for measuring risk in finance. However, it is important to remember that they are only a statistical concept and do not guarantee that an event will not occur.

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