Loading the player...

What is the '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. Positively skewed fat tails can be a sign of abnormal future returns.

RELATED TERMS
  1. Mesokurtic

    Mesokurtic is a statistical term describing the shape of a probability ...
  2. Tail Risk

    A form of portfolio risk that arises when the possibility that ...
  3. Normal Distribution

    A probability distribution that plots all of its values in a ...
  4. Probability Distribution

    A statistical function that describes all the possible values ...
  5. Standard Deviation

    A measure of the dispersion of a set of data from its mean, calculated ...
  6. Equity Curve

    An equity curve is a graphical representation of the change in ...
Related Articles
  1. Investing

    Stock Market Risk: Wagging The Tails

    The bell curve is an excellent way to evaluate stock market risk over the long term.
  2. Trading

    Trading With Gaussian Models Of Statistics

    The study of statistics originated from Carl Friedrich Gauss and helps us understand markets, prices and probabilities, among other applications.
  3. Investing

    Using Normal Distribution Formula To Optimize Your Portfolio

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

    The Linear Regression of Time and Price

    This investment strategy can help investors be successful by identifying price trends while eliminating human bias.
  5. Investing

    The Uses And Limits Of Volatility

    Check out how the assumptions of theoretical risk models compare to actual market performance.
  6. Investing

    Find The Right Fit With Probability Distributions

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

    Why Standard Deviation Should Matter to Investors

    Think of standard deviation as a thermometer for risk, or better yet, anxiety.
  8. 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.
  9. Insights

    Understanding The Treasury Yield Curve Rates

    Treasury yield curves are a leading indicator for the future state of the economy and interest rates.
  10. Investing

    A Flattening Yield Curve Is Good For The Economy and Stocks

    Wall Street is concerned because the yield curve is flattening, but that doesn't mean a recession is near.
RELATED FAQS
  1. What is the difference between standard deviation and average deviation?

    Understand the basics of standard deviation and average deviation, including how each is calculated and why standard deviation ... Read Answer >>
  2. What is the difference between term structure and a yield curve?

    Understand the difference between the term structure of interest rates and a yield curve, if any. Learn what the yield curve ... 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. 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. Fibonacci Retracement

    A term used in technical analysis that refers to areas of support (price stops going lower) or resistance (price stops going ...
  2. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  3. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  4. Financial Industry Regulatory Authority - FINRA

    A regulatory body created after the merger of the National Association of Securities Dealers and the New York Stock Exchange's ...
  5. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by companies seeking the capital to expand ...
  6. Cost of Goods Sold - COGS

    Cost of goods sold (COGS) is the direct costs attributable to the production of the goods sold in a company.
Trading Center