Chapter 1-2 Trading Terminology
Be professional in every aspect of your trading career. This includes the manner in which you communicate with your peers. By using the proper trading terminology you will project an aura of professionalism and success to the rest of the trading community. More importantly you will be able to communicate effectively with other decision makers. Behave like a winner. It’s both contagious and self-fulfilling.
The following terms are commonly used amongst traders. It is advantageous to memorize and understand each of these terms in order to develop into a successful trader. While this list does not contain every term we shall cover in the material, it shall provide a good starting point.
Arbitrage: A form of trading which attempts to profit by discrepancies due to location, funding, volatility, responses to information, or other differences.
Ask: Price at which a trader of the stock is willing to sell. Same as “Offer”. Asks/Offers are “taken”.
Bar Chart: Used to plot price movements using vertical bars indicating price ranges.
Basis Points: The measure of yields on bonds and notes; one basis point equals 0.01% of yield.
Bear Market: A securities market characterized by declining prices.
Bid: Price at which a trader of the stock is willing to buy. Bids are “hit”.
Bid/Ask Spread (or “Spread”): The distance between the Bid and Ask price.
Block Trades: Large transactions of a particular stock sold as a unit.
Book Value: The company’s’ assets minus its liabilities, plus liquidation price of any preferred issues.
Bull Market: A securities market characterized by rising prices.
Buying to Cover: After someone shorts shares of a stock, they repay back the shares they borrowed by buying the same shares back on the open market.
Breakout: The point when the market price moves out of the trend channel. (See chart below.)
Candlestick Charts: A charting method, originally from Japan, in which the high and low are plotted as a single line and are referred to as shadows. The price range between the open and the close is plotted as a narrow rectangle and is referred to as the body. If the close is above the open, the body is white. If the close is below the open, the body is black. (See chart below.)
Churning: An excessive amount of trading which results in generating a fare amount of commissions but very little trading profits.
Closed Trades: Positions that have been offset.
Congestion Area or Pattern: A period of trading in which there is no visible progress in price. (See chart below.)
Consolidation: Also known as a congestion period. A pause that allows participants in a market to reevaluate the market and sets the stage for the next price move.
Cyclical Stocks: Stocks that do well when the economy is in a recovery and do poorly when in a recession.
Daily Range: The difference between the high and low price during one trading day.
Dilution of Shares: Occurs when you add shares to the shares outstanding for a stock.
Divergence: When two or more averages or indices fail to show confirming trends. (See chart below.)
Dividend: A portion of the net profits paid directly to the stockholders, paid at a fixed amount.
Diversification: Reducing risk by investing in many securities and investments (such as 25% in bonds, 25% in mutual funds, and 50% in stocks).
Dollar Cost Averaging: A method of investing in a particular equity by investing a fixed amount at regular intervals. (For example, buying $1,000 worth of AMZN every month. You buy it at $71, $83, $76, and $90. Your dollar cost average is $80.)
Drawdown: The magnitude of a decline in account value, either in percentage or dollar terms, as measured from peak to subsequent trough. For example, if a trader’s account increased in value from $10,000 to $20,000, then dropped to $15,000, then increased again to $25,000, that trader would have had a maximum drawdown of $5,000 (incurred when the account declined from $20,000 to $15,000) even though that trader’s account was never in a losing position from inception.
Dow Jones Industrial Average: The average of 30 blue chip stocks hand-picked by the Wall Street Journal editors. The Dow is an indication of the well being of the overall market.
Earnings Per Share: Net income divided by the shares outstanding
Exit: The point at which a trader closes out of a trade.
Figure: Term commonly used to describe a whole number. (Example: $49.00)
Fill: An executed order; sometimes the term refers to the price at which an order is executed.
Float: The number of shares available for trade by the public that are not held by insiders or large investors.
Fundamental Analysis: Macro or strategic assessments of where a stock should be trading based on any criteria but the price action itself. These criteria often include the economic conditions monetary policy, and other “fundamental” elements.
Growth Stock: Stock of a company in which revenue and earnings are growing at an above average rate (more than about 15% a year).
Index Fund: A fund that has the goal of matching the performance of an index, such as the S&P 500, by buying the exact stocks that comprise the index.
Initial Public Offering (IPO): A company’s first offering of stock to the public in order to raise money.
Limit: An order to buy at a specified price when the market moves down to that price, or to sell at a specified price when the market moves up to that price.
Limit Order Book (Open Book): The limit order book contains all the limit orders placed through the NYSE. Only orders that are 100 shares or higher in lots of 100 will appear on the book. The limit order book constantly refreshes as the limit orders are placed, filled, or cancelled. Keep in mind that the limit order book does not represent the entirety of orders in a single stock, but just limit orders sent electronically to the NYSE. Such orders as market orders, stop orders, crowd, and ECNs are not represented on the limit order book.
Liquidity: A function of volume and activity in a market. It is the efficiency and cost effectiveness with which positions can be traded and orders executed. A more liquid market will provide more frequent price quotes at a smaller bid/ask spread.
Margin Buying (Buying Stocks on Margin): Interest on borrowing on margin is far lower than any credit card and about as cheap as a home mortgage interest rate. If used properly is can be a great tool. You are allowed to borrow up to 50% of your stock’s current value. You can use that borrowing power to buy more stock or use the cash for something else. So with $1,000 worth of cash you can buy $2,000 worth of stock and borrow $500 worth of cash.
Margin Call: When the % of equity verses the debt falls below the broker’s minimum standards, a call is issued to either come up with the money to bring the equity back to 50% or the shares of the portfolio will be sold to bring it up to 50%. There are typically only a few days to raise the money. (For example, if you have $1,000 and buy 20 shares of IBM at $100 a share (borrowing $1,000), and your broker’s minimum requirement is 30%, then you will get a margin call if IBM drops to $71.25. After your margin call you are either expected to pay $575 or 8 shares of your IBM will be sold bringing your total value of your portfolio to $425. Using margin can double your profits or double your losses. It is wise to either not use margin or borrow 20% or less of your stock’s value.
Market Maker: A broker or bank continually prepared to make a two-way price to purchase or sell for a security or currency.
Market Risk: The uncertainty of returns attributable to fluctuation of the entire market.
Market Sentiment: Crowd psychology, typically a measurement of bullish or bearish attitudes among investors and traders.
Market Timing: Using analytical tools to devise entry and exit methods.
Market Order: Instructions to immediately sell to the best available bid or to buy from the best available offer.
Marketable Limit Order: A limit order that is placed through the current quote price in order to increase the probability of execution. The type of order guarantees an entry no higher than desired if buying (no lower than desired if shorting), while increasing the probability of execution. However, there is still some possibility of the order not being executed, especially in faster moving trades.
Moving Average: A mathematical procedure to smooth or eliminate the fluctuations in data and to assist in determining when to buy and sell. Moving averages emphasize the direction of a trend, confirm trend reversals and smooth out price and volume fluctuations or “noise” that can confuse interpretation of the market; the sum of a value plus a selected number of previous values divided by the total number of values. (See chart below.)
Moving Average Crossovers: The point where the various moving average lines intersect each other or the price line on a moving average price bar chart. Technicians use crossovers to signal price-based buy and sell opportunities. (See chart below.)
Offer: Price at which a trader of the stock is willing to sell. Same as “Ask”.
Overbought: An equity (or market) that has gone up in virtually a straight line, creating a price “too high” to justify according to the underlying company’s actual value, making the stock overvalued, and due for a correction.
Oversold: An equity (or market) that has gone down to which its valuation seems to support buying of the stock.
P/E Price/Earnings Ratio: Current price of the shares divided by the EPS (earnings per share)
Pivot Point: In market activity, a price reversal point.
Scalp: A speculative attempt to make a quick profit.
Seasonality: A consistent and predictable change in market activity that occurs from consistent and predictable events.
Secondary Offering: Selling of a large block of shares, issued by companies to raise additional money. Some of the shares that make up the offering could be from insiders selling and some may be new shares issues thus increasing the outstanding shares and dilution.
Sector Rotation: When a block of investment professionals cash out of one industry sector to invest in another.
Shares Outstanding: Total number of shares issued by a corporation.
Short Sale: Selling shares of a stock that you do not own by borrowing the shares to sell. The goal is to buy them back at a cheaper price for a gain if you think the stock is going to drop.
Split: To increase or decrease the number of shares outstanding requires stockholder approval; (a 2 for 1 split would double the outstanding shares).
Squeeze: A term used to describe a drastic change in price action due to a sudden lack of liquidity as a result of prevailing market conditions.
Stop: An order to buy at the market only when the market moves up to a specific price, or to sell at the market only when the market moves down to a specific price.
Support: A historical price level at which falling prices have stopped falling and either moved sideways or reversed direction; usually seen as a price chart pattern. (See chart below.)
Technical Analysis: Analysis applied to the price action of the market to develop trading decisions, irrespective of fundamental factors.
Tick: The smallest price increment in an index or stock. For example, in Down Jones Industrials, a move from 8845 to 8846 is one tick. In S&P 500, a move from 902.50 to 902.51 is one tick.
Ticker Symbol: A short abbreviation used to uniquely identify publicly traded shares of a particular stock on a particular stock market.
Trading Range: The difference between the high and low prices traded during a period of time; in commodities, the high/low price limit established by the exchange for a specific commodity for any one day’s trading. (See chart below.)
Trailing Stop (T-Stop): A stop-loss order that follows the prevailing price trend.
Trend: The general drift, tendency or bent of a set of statistical data as related to time.
Trend Channel: A parallel probable price range centered about the most likely price line. Historically, this term has been used to denote the area between the base trendline and the reaction trendline defined by price moves against the prevailing trend. (See chart below.)
Trendline: A line drawn that connects either a series of highs or lows in a trend. The trendline can represent either support as in an uptrend line or resistance as in a downtrend line. Consolidations are marked by horizontal trendlines. (See chart below.)