- 22 Basic US Stock Market terms you should know before investing
- 1. Buy
- 2. Sell
- 3. Bid
- 4. Stock
- 5. Bull Market
- 6. Bear Market
- 7. Beta
- 8. Yield
- 9. Market Order
- 10. Day Order
- 11. Liquidity
- 12. Volatility
- 13. Trading
- 14. Going Long
- 15. Going Short
- 16. Market Capitalization
- 17. IPO
- 18. Margin
- 19. Moving Average
- 20. LRS
- 21. ADR
- 22. Stock Market Index
A US Stocks market or a financial market is a place where individuals participate to invest, trade and earn profits. However, it is not a physical place and complex terms like bull market, bear market, market capitalisation, volatility, and margin float around. This article helps in developing a better understanding of the different US stock market terms better.
22 Basic US Stock Market terms you should know before investing
Below is a list of important stock market terms that one must know to invest in stock market.
Buy means to purchase an asset or take a long position. In other words, it means owning a security. An investor buys the share or security or an asset at the current market price. Therefore, one owns an asset or security in exchange for payment, either in the form of money or equivalent value. Also, a buy order is an instruction the investor gives their broker to buy a security.
Sell means liquidating an asset or taking a short position. An investor liquidates the share or security or an asset at the current market price. Liquidation is the process of converting non-liquid assets, such as stocks, bonds or real estate, into cash (liquid asset). This is done through an open market exchange. Also, a sell order is an instruction the investor gives their broker to sell a security.
A bid price is the highest price that a potential investor is willing to pay for a security. A bid is an offer to acquire securities made by an investor, trader, or dealer that specifies the price and quantity the buyer is willing to pay. In trading, the bid-ask spread is the difference between the price that the buyers are willing to pay and the price the sellers are asking for. In simple words, the bid and ask terms refer to the supply and demand of a stock or security.
It is one of the most used US stock market terms. A stock is the collection of shares of either a single company or of multiple companies. In other words, it is the shares into which the ownership of a corporation is divided. While a share is the smallest unit by which a person’s ownership in any company is ascertained. A single share of a stock represents a fraction of ownership of the company. Investors can buy or sell stocks either privately or on the stock exchange.
5. Bull Market
A bull market scenario is when the stock market is in a prolonged upward trend. In other words, the stock prices in the market are increasing for a prolonged duration. Furthermore, a single stock or a sector can also be bullish. This often encourages buying, and as a result, the asset prices continue to rise. Investors are optimistic about the market or the economy, and the aggregate stock market prices are rising.
6. Bear Market
A bear market scenario is exactly the opposite to a bull market scenario. A bear market scenario is when the stock market is in a prolonged downward trend. In other words, the cumulative stock prices in the market are declining for a prolonged duration. Furthermore, a single stock or a sector can also be bearish. This often encourages selling, and as a result, the asset prices continue to fall. Investor’s pessimism, negative sentiments, fear about the market or the economy drive the aggregate stock market down.
This stock market term is the measure of an asset’s risk in accordance with the market or benchmark. For example, if a security’s beta is 2, it means that the security prices move 1.5 times the market return. In simple terms, if the market moves by 1 point, the security price changes by 2 points. Therefore, if the stock market increases by 1 point, the security prices increase by 2 points and vice versa.
The beta is an important metric for determining how much risk a stock adds to a portfolio. High beta stocks are risky in comparison to market movements, but they also have a greater return potential. Low beta stocks, on the other hand, are less risky and hence lower are the returns.
Also, it is important to note that beta measures the co-movement of a stock and not its volatility. It is often possible to have a security with zero beta and higher volatility than the stock market.
Yield is the percentage return on a stock, often in the form of dividends. Also, yield is the effective interest rate an investor gets on bonds. Simply put, yield measures the return on investment. For example, if an investor invested in a company whose share price is INR 100 and the dividend per year is INR 5. The yield for the investor is (5/100)*100 = 5%.
9. Market Order
A market order is an order to buy or sell a share at the current market price. The market prices are always highly volatile. Therefore, the execution price of the buy or sell order is not guaranteed. Most commonly, the market order is executed at the current bid price (for a sell order) or ask price (for a buy order). Hence, it is important to note that the last traded price is not necessarily the at which the market order gets executed.
10. Day Order
A day order is an order that holds good only till the end of the trading day. If the order doesn’t get executed by the end of the trading day, then it would be cancelled. Unless otherwise mentioned, all orders are processed on the same day. A day order can be a limit order to buy or sell a security, however, limited to the duration of the trading day.
Day orders are useful if an investor wishes to buy a security at a specific price point. Setting a day order saves the time of an investor from constantly monitoring the prices of the security.
Liquidity means a high level of trading activity. High liquidity allows buying and selling with the least effect on market price. In simple terms, liquidity is a measurement of how easily one can buy or sell the asset at a price reflecting its intrinsic value. Therefore, securities with high trading volumes in the stock market are often highly liquid.
Also, if a stock market exchange has a high trade volume that is not dominated by selling, then the bid price and the ask price will be close to each other. Furthermore, when the bid-ask spread widens, then the market becomes illiquid.
Volatility is a statistical measure of the dispersion of returns of a given financial security from its mean. It is measured using standard deviation or variance. The higher the volatility of a security, the greater is the risk involved. Volatility indicates a major swing in the price of security in either direction.
Volatility usually indicates the amount of uncertainty in the prices of a security. The higher the volatility, the larger is the range of movement of security’s value. In other words, the price of security can change drastically in the short term. Volatility is annualized standard deviation and is reported daily, weekly, monthly, or annually. It can also be used to price options contracts. The higher the volatility, the more will be the option premium. As volatile securities have a higher probability of being in the money at expiration.
Trading is a stock market term/activity that involves active participation in the financial market. It involves continuous buying and selling securities with the aim to earn profits. Unlike investing, which involves buy and hold strategy using fundamentals and other criteria, trading focuses on company-specific events, market rumours, and other factors to trade in a stock.
A trader is a person who does trading, and the success of trading depends on a trader’s ability. Trading is a short term activity and lasts for a day and up to a year. Trading is risker when compared to investing, as volatility in the market in the short term is usually higher. Moreover, trading comes with high capital gains tax and other brokerage and transaction costs.
14. Going Long
Going long in a share market means buying security. A long position usually means buying security with an expectation of an increase in the value or price of the security. In other words, they are bullish about the market or the security.
An investor can either go long on the security or an options contract. Suppose the investor is going long on the security. In that case, the investor is holding the stock and is bullish about it. They have an expectation that the price will rise and usually has no intention of selling it in the near future. If traders are going long on the options contract, then they might expect the price to either fall or rise in the future. If they go long on-call, they expect the price to go up. On the other hand, if they go long on put, they are bearish about the market and expect the prices to go down.
15. Going Short
Going short in a financial market means selling a security or a contract that the seller doesn’t own. While going short, the investor usually borrows the stock from the exchange and sells them at a higher price with an expectation that the prices will come down. Later, they buy the stock at a lower price to fulfil their trade, close the position and return back the shares to the bank.
Traders or investors who go short have a bearish sentiment about the market. The profit is the difference between the buy and sell price of the stock. Going short or short selling is very risky as there are chances the stock price may shoot up for unknown reasons leading to huge losses.
16. Market Capitalization
The value of a company in the financial market is known as market capitalization. In other words, it is the value of all the outstanding shares of a company. It is calculated by multiplying the total outstanding shares by the market price of the share. It is to be noted that only outstanding shares or shares available to the public for trading are to be considered to determine market capitalization. Promoter shares and shares of other institutional buyers are not included in it.
Market capitalization is the easiest way to determine the value of a publicly-traded company. Also known as market cap, it also determines the size of the company. Based on market cap, companies can be large-cap, mid-cap and small-cap companies. Market capitalization is also a major factor while deciding the stocks for an index.
IPO or Initial Public Offering is the process by which a company offers private shares to the public for trading for the first time. Through an IPO, a company can be listed on the stock exchange and can individuals can start investing in the company thrrough the stock market. Companies prefer an IPO when they want to raise capital for the expansion of business. They have to follow SEBI regulations to go public.
They usually hire investment banks to assist with the entire IPO process. Investment banks help right from marketing the IPO to setting the price and date of the IPO. Initial Public Offering (IPO) happens in the primary market. When a company issues shares for the first time through IPO, they trade in the primary market. Investors apply for shares in the primary market. After the shares are allotted to the public, they trade in the secondary market.
Margin is the amount of money an investor has to deposit with the exchange to get credit to trade in financial securities. When an investor wants to buy a security on credit, he/she pays an initial amount called margin. The broker lends the rest.
Margin acts as collateral against the money lent by the broker. The investor uses the current cash he holds to buy financial securities. This cash acts as collateral for the purchase. Margin requirements change from broker to broker. Let’s take an example of an investor who wants to invest in shares worth INR 10,000. It has a margin requirement of 40%. The investor can only invest INR 4,000 and borrow the rest INR 6,000 from the broker. The INR 4,000 is the margin.
19. Moving Average
Moving average is a statistical measure that analyses data by grouping them into subsets of the full data and taking their averages. It is also a technical indicator that traders and analysts use to determine the security’s average price. Moving averages mitigates the effect of short term price fluctuations on the price of the stock over a period of time.
Moving averages help in determining the trend of a stock and also the support and resistance levels. The most widely used moving averages are 50 days moving average and 200-day moving average. The longer the time period of moving average, the greater is the lag. Hence a 200-day moving average will have a greater lag than 50 days moving average.
Liberalized Remittance Scheme (LRS) is an RBI scheme that allows individuals to remit a certain amount of money to another country for the purpose of investment and expenditure. As per the current regulations, resident Indians can remit up to $250,000 per financial year.
The amount remitted can be used for travelling expenditure, making donations, studying abroad, medical treatment, business, and investing. The remitted money can be invested in shares, debentures, immovable property, and also transferred to hold foreign currency accounts abroad. However, the scheme lists out countries to where the money can be remitted to.
American Depository Receipts or ADR is the receipt issued by the US depository bank. It represents the shares of a foreign company. An ADR trades on the US stock market similar to how the shares of a US company would.
ADRs are a means for US residents to purchase shares of a foreign company. It also benefits the foreign company as they can get access to capital from US investors without listing on US stock exchanges. A bank in the US buys shares from a foreign company and issues ADRs to them. They hold stock of the shares and make it available to investors and traders in the US. ADRs are denominated in USD, and hence investors need not worry about converting the currency and additional conversion charges.
22. Stock Market Index
A stock market index is an indicator of the overall sentiment of the capital market and the industry in a country. A stock market index is made of similar stocks that represent the entire market. Each stock exchange has its own criteria to pick stocks. It can be industry, market cap, size, or profitability. The value of the index is dependent on the prices of the underlying stocks. If the price of the stocks that make up the index go up or down, the index value goes up or down.
A stock market acts as a barometer for the economy and the market’s health. It also acts as a benchmark for an investment portfolio and helps in picking stocks. Investors who want to invest in the market are unable to pick stocks for the portfolio, they can mimic the index and make a passive portfolio.