If you are new to trading stocks, the sheer volume of stock market terms can be off-putting. But learning some basic stock trading terminology is a great place to begin before investing any money. For any new investor just getting into trading, getting a grasp on some basic stock market terms can be extremely helpful.
The Significance of Knowing Stock Market Terminology
It’s important to have at least a grasp of some basic stock market terms if you plan on trading or investing. If you don’t do a bit of homework beforehand, you may find yourself feeling in over your head, and grasping for help from family members, friends, or a financial professional.
While there are a multitude of different stock market terms out there, it isn’t terribly difficult to develop an understanding of the basics. Yes, it’ll take some time and practice, but like learning anything else, once you get the hang of it, it should become easier as you move along in your investment journey.
💡 Quick Tip: Investment fees are assessed in different ways, including trading costs, account management fees, and possibly broker commissions. When you set up an investment account, be sure to get the exact breakdown of your “all-in costs” so you know what you’re paying.
To get a fundamental understanding of the stock market, it can be helpful to start with some relatively basic terms, including the following.
Asset allocation involves investing across asset classes in a portfolio in order to balance the different potential risks and returns, and there are three main asset classes, which are typically stocks, bonds, and cash. Asset allocation is closely tied with portfolio diversification.
There are several asset classes, or types of assets, that investors can invest in. This can include, but is not limited to, stocks, bonds, money market accounts, cash, real estate, commodities, and more. You can also think of certain assets as equities, debt securities, and more.
Bid, in the context of bid-ask spread, refers to the “bid price” that an investor is willing to pay for a security or investment.
Ask, in the context of bid-ask spread, is the opposite of bid, and is the lowest price that investors are willing to sell a security for.
The bid-ask spread is the difference between the bid and ask price, and can be a measure of liquidity. When the bid and ask prices match, a sale takes place, on a first-come basis if there is more than one buyer. The bid-ask spread is the difference between the highest price a buyer is willing to bid, and the lowest price a seller is willing to ask.
There are a number of market phrases, or types of jargon that may be used in and around the stock market, too. Here are some examples.
A bull market describes market conditions when a market index rises by at least 20% over two months or more, and is often used to describe high levels of confidence and optimism among investors.
A bear market describes a 20% fall in a market index, and is the opposite of a bull market. It can signal overall pessimism among investors.
Market volatility refers to how much a market index’s value increases or decreases within a specific period of time. Volatility can occur for a number of reasons.
There are many specific investment vehicles that investors should know about, too, including different types of stocks, bonds, and more.
Bonds are a type of debt security, which effectively means that investors are loaning money to the issuer. There are many types of bonds, and they’re often considered to be a less-risky investment alternative to, say, stocks.
Common stock, also known as shares or equity, is like owning a piece of a company. You purchase stock in a company, and receive a proportional part of that corporation’s assets and earnings. The price of stock is different for each company and fluctuates over time.
Preferred stock is similar to common stock, but usually grants shareholders some sort of preferential treatment, such as advanced dividend payments, and more.
ETFs, or “exchange-traded funds,” are types of funds that trade on exchanges like stocks. Investors can purchase shares of ETFs, which incorporate numerous different types of securities (like a “basket” of different investments), and may offer built-in diversification as an advantage for investors.
Mutual funds are companies or entities that pool money from numerous different investors and then invest it on their behalf. A manager oversees a mutual fund, and actively manages it. Investors can purchase shares of mutual funds, which are similar to ETFs in many ways.
Stock Analysis Terms
Analyzing the stock market incorporates its own set of terminology, and it can be helpful for investors to know a bit of the vernacular.
Earnings Per Share (EPS)
Earnings per share, often shortened as “EPS,” is a ratio that helps determine a company’s ability to drive profits for shareholders. It’s a common and oft-cited business metric for investors.
A dividend is a payment made from a company to its shareholders, often drawn from earnings. Usually, these are made in cash, but sometimes they are paid out as additional stock shares. They are typically paid on an annual or quarterly basis, and typically only come from more established companies, not startups.
Dividend yield refers to how much a company pays out to shareholders on an annual basis relative to its share price. It’s a ratio that’s calculated by dividing the company’s dividend by its share price.
The Price-to-earnings (P/E) Ratio
The price-to-earnings ratio (often written as the P/E ratio, PER, or P/E) is a ratio of a company’s current share price relative to the company’s earnings per share. It can be used to compare performances of different companies.
💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.
Price Movements and Pattern Terms
There are also a number of movement and pattern terms that investors may want to familiarize themselves with.
Trading volume refers to how much trading is happening on an exchange. For a stock trading on a stock exchange, the stock volume is typically reported as the number of shares that changed hands during any given day. It’s important to note that even with an increasing price, if it’s paired with a decreasing volume, that can mean a lack of interest in a stock. A price increase or drop on a larger volume day (i.e., a bigger trading day) is a potential signal that the stock has changed dramatically.
Volume-weighted Average Price (VWAP)
Volume-weighted average price, or VWAP, is a short-term price trend indicator used when analyzing intraday, or same-day, stock charts. It’s a type of technical analysis indicator.
Trading Order Types and Execution
Investors need to know the types of orders that they’re likely to use throughout their investing journey. Those include market orders, limit orders, and stop-loss orders.
A market order is the most common type of order, and it means that an investor wants to buy or sell a security as soon as possible at the current market price.
Limit orders are another common type of order, and involve an investor placing an order to buy or sell a security at a specific price or within a specific time frame. There are two types: Buy limit orders, and sell limit orders.
Stop-loss orders, or sometimes called stop orders, are orders that specify a security to be sold at a certain price.
Day Trading Terms
For the prospective day-trader, there are a slate of terms to know as well.
Day trading involves an investor making short-term trades on a daily or weekly basis in an effort to generate returns off of price fluctuations in the market. There are numerous day trading strategies that investors can utilize.
Pattern Day Trader
A pattern day trader is a designation created by FINRA, and refers to traders who trade securities four or more times within five days. There are rules and stipulations that pattern day traders, and their chosen trading platforms, must follow.
A trading halt can refer to a specific stock or the entire market, and involves a halt to all trading activity for an indefinite period of time.
Long-term Investment Terms
The opposite of day trading, long-term investing also ropes in its own jargon.
Averaging down involves a scenario in which an investor already owns some stock but then purchases additional stock after the price has dropped. It results in a decrease in the overall average price for which you purchased the company stock. Investors can profit if the company’s price subsequently recovers.
Diversification refers to investing in a wide range of assets and asset classes, as opposed to concentrating investments in a specific area or class.
Dollar-cost averaging is a strategy to manage volatility in a portfolio, and involves regularly investing in the same security at different times, but with the identical amount. Effectively, the cost of those investments will average out over time.
Derivatives and Market Predictors
Getting into the weeds now — derivatives and market predictors are more high-level market elements, but it can be helpful to know some of the terminology.
Futures, or futures contracts, are a form of derivatives that are a contract between two traders, agreeing to buy or sell an asset at a specific price at a future date.
Options trading involves buying and selling options contracts, of which there are many types.
Arbitrage refers to price differences in the same asset on different markets. Traders may be able to take advantage of those differences to generate returns.
Financial Health Indicators
We’re not done yet — these terms involve financial health indicators.
Debt-to-equity is a financial metric that helps investors determine risks with a specific stock, and is calculated by dividing a company’s equity by its debts.
Market liquidity is essentially how easily shares of stock can be converted to cash. The market for a stock is “liquid” if its shares can be sold quickly, and the act of selling only minimally impacts the stock price.
Profit margin refers to how much profit is generated from a trade when expenses are considered. Lowering related expenses can increase profit margin, all else being equal.
Knowing some key economic terms can be helpful when trying to size up larger economic and market trends.
Volatility refers to the range of a stock price’s change over time. If the price stays stable, then the stock has low volatility. If the price jumps from high to low and then back to high often, it would be considered more of a high-volatility stock.
Economic bubbles or market bubbles are often created by widespread speculative trading, and involve a runup or buildup of prices for a given asset, which can be detached from its actual value. Eventually, the bubble tends to burst and investors may incur a loss.
A recession is a period of economic contraction, and is usually accompanied by higher unemployment rates, business failures, and lower gross domestic product figures. Recessions are officially declared by the Business Cycle Dating Committee at the National Bureau of Economic Research.
Adaptation and Risk Management
For particularly savvy investors, knowing some terms relating to adaptation and risk management can also be helpful when navigating the markets.
Sector rotation involves investing in different sectors of the economy at different times, and rotating holdings between those sectors in an effort to generate the biggest returns.
Hedging is an investment strategy that involves limiting risk exposure within different parts of a portfolio, and there are many methods or strategies for doing so.
Learning some basic stock market terms can go a long way toward helping an investor navigate the markets, and there are a lot of terms and jargon to get familiar with. But doing a bit of homework early on can be enormously helpful so that you’re not trying to figure things out on the fly as an investor.
While you’re not going to learn everything right off the bat, if you start to spend a lot of time investing and trading, you’re likely to quickly catch on to certain terms, while others will come with time. As always, if you have questions, you can reach out to a financial professional for help — or do a bit more research on your own.
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