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Alexa has a description of how the ranking works.
What is Traffic Rank?
The traffic rank is based on three months of aggregated historical traffic data from millions of Alexa Toolbar users and is a combined measure of page views and users (reach). As a first step, Alexa computes the reach and number of page views for all sites on the Web on a daily basis. The main Alexa traffic rank is based on the geometric mean of these two quantities averaged over time (so that the rank of a site reflects both the number of users who visit that site as well as the number of pages on the site viewed by those users). The three-month change is determined by comparing the site's current rank with its rank from three months ago. For example, on July 1, the three-month change would show the difference between the rank based on traffic during the first quarter of the year and the rank based on traffic during the second quarter.
What is Reach?
Reach measures the number of users. Reach is typically expressed as the percentage of all Internet users who visit a given site. So, for example, if a site like yahoo.com has a reach of 28%, this means that if you took random samples of one million Internet users, you would on average find that 280,000 of them visit yahoo.com. Alexa expresses reach as number of users per million. Alexa's one-week and three-month average reach are measures of daily reach, averaged over the specified time period. The reach rank is a ranking of all sites based solely on their reach. The three-month changes are determined by comparing a site's current reach and reach rank with its values from three month ago.
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