Loading the player...

What is a 'Bell Curve'

A bell curve is the most common type of distribution for a variable, and due to this fact, it is known as a normal distribution. The term "bell curve" comes from the fact that the graph used to depict a normal distribution consists of a bell-shaped line. The highest point on the curve, or the top of the bell, represents the most probable event in a series of data, while all other possible occurrences are equally distributed around the most probable event, creating a downward-sloping line on each side of the peak.

BREAKING DOWN 'Bell Curve'

Bell curve is a general term that's used to describe a graphical depiction of a normal probability distribution. The normal probability distribution's underlying standard deviations from the median, or from the highest point on the curve, is what gives it the shape of a curved bell. A standard deviation is a measurement used to quantify the variability of data dispersion in a set of values. The mean is the average of all data points in the data set or sequence.

Standard deviations are calculated after the mean is calculated and represent a percentage of the total data collected. For example, if a series of 100 test scores are collected and used in a normal probability distribution, 68% of the 100 test scores should fall within one standard deviation above or below the mean. Moving two standard deviations away from the mean should include 95% of the 100 test scores collected, and moving three standard deviations away from the mean should represent 99.7% of the 100 test scores. Any test scores that are extreme outliers, such as a score of 100 or 0, would be considered long-tail data points and lie outside of the three standard deviation range.

Bell Curves in Finance

Financial analysts and investors often use a normal probability distribution when analyzing the returns of a security or of overall market sensitivity. Standard deviations that depict the returns of a security are known in the finance world as volatility. For example, stocks that display a bell curve are normally blue chip stocks and have lower and predictable volatility. Investors use the normal probability distribution of a stock's past returns to make assumptions regarding its expected future returns.

However, stocks and other securities sometimes display non-normal distributions, meaning that they do not look like a bell curve. Non-normal distributions have fatter tails than a normal probability distribution. If the fatter tail is skewed negative, it's a signal to investors that there is a greater probability of negative returns and vice versa.

RELATED TERMS
  1. Normal Yield Curve

    The normal yield curve is a yield curve in which short-term debt ...
  2. Empirical Rule

    A statistical rule stating that for a normal distribution, almost ...
  3. Excess Kurtosis

    Excess kurtosis describes a probability distribution with fat ...
  4. Equity Curve

    An equity curve is a graphical representation of the change in ...
  5. Term Structure Of Interest Rates

    The term structure of interest rates is the relationship between ...
  6. Downside Risk

    An estimation of a security's potential to suffer a decline in ...
Related Articles
  1. Investing

    Optimize your portfolio using normal distribution

    Normal or bell curve distribution can be used in portfolio theory to help portfolio managers maximize return and minimize risk.
  2. Investing

    What's Skewness?

    Skewness describes how a data distribution leans.
  3. Investing

    Find the right fit with probability distributions

    Discover a few of the most popular probability distributions and how to calculate them.
  4. Investing

    Bond yield curve holds predictive powers

    This measure can shed light on future economic activity, inflation levels and interest rates.
  5. Investing

    Why Standard Deviation Should Matter to Investors

    Think of standard deviation as a thermometer for risk, or better yet, anxiety.
  6. Investing

    Lognormal and normal distribution

    When and why do you use lognormal distribution or normal distribution for analyzing securities? Lognormal for stocks, normal for portfolio returns.
  7. Investing

    Understanding Quantitative Analysis Of Hedge Funds

    Analyzing hedge fund performance quantitatively requires metrics such as absolute and relative returns, risk measurement, and benchmark performance ratios.
  8. Investing

    Interest Rates and Your Bond Investments

    By understanding the factors that influence interest rates, you can learn to anticipate their movement and profit from it.
  9. Investing

    Understanding Volatility Measurements

    How do you choose a fund with an optimal risk-reward combination? Here we teach you about standard deviation, beta and more.
  10. Insights

    Is a Recession in the Works? Ask an Inverted Yield Curve

    An inverted yield curve has predicted the last seven recessions. Is number eight around the corner?
RELATED FAQS
  1. What does standard deviation measure in a portfolio?

    Dig deeper into the investment uses of and mathematical principles behind standard deviation as a measurement of portfolio ... Read Answer >>
  2. How is standard deviation used to determine risk?

    Understand the basics of calculation and interpretation of standard deviation, and how it is used to measure and determine ... Read Answer >>
  3. What is the difference between the expected return and the standard deviation of ...

    Learn about the expected return and standard deviation and the difference between the expected return and standard deviation ... Read Answer >>
  4. How is risk aversion measured in Modern Portfolio Theory (MPT)?

    Find out how risk aversion is measured in modern portfolio theory (MPT), how it is reflected in the market and how MPT treats ... Read Answer >>
  5. What is the difference between standard deviation and z score?

    Understand the basics of standard deviation and Z-score; learn how each is calculated and used in the assessment of market ... Read Answer >>
Hot Definitions
  1. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative ...
  2. Internal Rate of Return - IRR

    Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments.
  3. Limit Order

    An order placed with a brokerage to buy or sell a set number of shares at a specified price or better.
  4. Current Ratio

    The current ratio is a liquidity ratio that measures a company's ability to pay short-term and long-term obligations.
  5. Return on Investment (ROI)

    Return on Investment (ROI) is a performance measure used to evaluate the efficiency of an investment or compare the efficiency ...
  6. Interest Coverage Ratio

    The interest coverage ratio is a debt ratio and profitability ratio used to determine how easily a company can pay interest ...
Trading Center