Let’s start with a simple question – Why is it important to learn about the stock market terminology? To answer that question, we must first learn about what stock markets are.
What are stock markets?
Like any market, a stock market is a place where trade happens. The only difference is that the trade goods in stock markets are equity shares and not physical products.
When a business grows exponentially, it takes a lot of money to run it efficiently. Where does this money come from?
The businesses raise capital from the stock market, where individual people like you and I can invest in the company by buying a share of the company. In return, when the business gains profit, the investors also get a share of it as owned by them.
In simple terms, the stock market is where the buyers and sellers meet to make trades.
Among the participants of the stock market are the investors, who invest in the stock market for a long-term capital gain and there are the traders who are in for a quick profit. They take advantage of the short ups and downs in the market.
These trades and investments happen not in a physical market, but over a virtual one.
Now that we get a basic idea about how stock trading and the stock market works, let us try to understand why it is important to learn the stock market terms.
How to buy a stock?
Stocks are mostly bought and sold in the stock exchanges.
When a company gets listed and goes public through an initial public offering (IPO), the stocks of that company become available for investors and traders to buy and sell on an exchange. Ideally, investors use a brokerage account to buy the stock on the exchange, in which the bid price and or the offer price will be listed.
The stock prices are influenced by the supply and demand of particular stocks in the market, along with a few other variables.
Importance of stock market terminology
Every industry has its own set of industry-specific jargon, and to be proficient in that industry, one must understand them. Similarly, the stock market also comes with some stock market terminologies, and since this industry is open to all for trading, anyone who wishes to get successful here must know them.
Experts and amateurs of the industry use these terms alike to explain the trading strategies, stock indices, market patterns, and other events. And that is another reason why it is important to understand the stock market terms.
Understanding these terms will also enhance the way you understand the relationship between stock markets and the events happening in the economy as well as to gain a piece of basic domain knowledge.
While there are a number of stock market terms that are used in the market, we’ll discuss the twenty most commonly used terms in the following section.
Basic stock market terms you should know
For a beginner or a neophyte trader or an investor, understanding the stock market can be seen as a challenging task. There are some confusing terms and concepts that will be frustrating for you. Hence it will surely help if you are familiar with these terms before you get into stock trading.
Here are a few stock market terms to improve your stock market vocabulary to help you in becoming a better and successful investor.
What is a share market? In simple terms, any place where one can buy or sell shares is called a share market. Any and all stock exchanges across the country are a part of this share market. Even any shares that you buy outside the stock exchange are also part of the share market.
There are two types of share market in general. Let’s take a look at what they are.
In this market, a company or government raises the capital it needs by the method of trading. The issue here is either through a public or personal placement. If the allotment of shares is over two hundred persons, then the issue is public and if it is less than two hundred, then the issue is personal.
The shares bought within the primary market are sold within the secondary market. This market mostly operates through over-the-counter (OTC) and exchange-traded markets about which we will learn in detail in the later section of this article.
The markets, as discussed above, in India are regulated by the SEBI, or Security and Exchange Board of India. A stock exchange is what facilitates the stockbrokers to trade a company’s stocks as well as other securities in the stock market.
To buy or sell a particular stock, it is mandatory for the company whose stocks you are trading to be listed on an exchange. Thus, the stock exchange acts as a meeting place for the buyers and sellers. India has two premier stock exchanges and that is the Bombay Stock Exchange and the National Stock Exchange.
Here’s an interesting fact. Do you know which is the largest stock exchange in the world?
The largest stock exchange in the world is the New York Stock Exchange with an equity market capitalization of just over 28.4 trillion U.S. dollars as of September 2021. The other three exchanges are the NASDAQ, the Shanghai Stock Exchange, and Euronext.
An over-the-counter or OTC market is a decentralized market for trading stocks, in which the participants trade stocks, commodities, currencies, or other instruments. The trading here happens directly between two parties with no brokers or central exchange trading system involved.
In the over-the-counter markets, trading session is conducted electronically, as they do not have a physical location.
An over-the-counter market is primarily used to deal with the trade of bonds, currencies, derivatives, and structured products. The OTC markets are also used to trade equities.
Like in any other trading market, the over-the-counter market also comes with its own risks. Although in normal times an OTC market may function really well, there is an additional risk in the over-the-counter market, known as a counter-party risk.
Counterparty risk is where one party in the transaction will default prior to the completion of the trade or fail to make the payments as required of them by the contract. In addition to that, a lack of transparency in the market can also cause a vicious cycle to develop during times of financial stresses.
Stock or share are the words that we hear quite often in the stock market. Let’s try and understand what stocks are in their simplest form.
Stocks or shares, also known as equity, are a representation of a fraction of any business or corporate that is listed. Owning a particular stock refers to owning a fraction of an organization that issued the stock.
Any person who holds stocks of a company becomes its shareholder. The stocks owned by a person can be in the form of commodities, equities, or bonds.
Depending on what type of share a shareholder owns, he may have a claim to a part of a business’s assets and profits who shares the person holds.
Ideally, there are two types of stocks – Common stocks and preferred stocks. Let’s take a look at what they are.
If you own common stock, that gives you the authority to cast a vote at the shareholder’s meeting as well as entitles the owner to the dividend paid out by the corporation if any.
Unlike the common shareholders, the preferred stockholders do not get to make a vote. Although, as preferred stockholders, they do have a higher claim to a company’s assets and dividends.
As simple as that!
Let’s start simple. When you think of big corporations, what are the first few names that come to your mind? Did you think of brands like Reliance, HDFC, Infosys, or TCS? Good job!
A blue-chip stock is nothing but a huge company with an excellent reputation that precedes them. These companies are large, well-established and are sound financially, and may have operated for many long years with dependable earnings and often paying dividends to investors without fail.
The blue-chip stocks have billions of market capitalization and are considered as the market leaders in the sector.
For all of these reasons and more, blue-chip stocks are the most popular in the stock market to buy among investors.
While it is true to an extent that blue chips have the potential to survive the many kinds of market challenges, this cannot be guaranteed. Hence, as an investor, it is always important to diversify the portfolio and not just invest in blue chips.
Here’s an interesting fact – the term blue chip comes from poker, where blue chips are the most expensive of all chips.
Brokers in the stock market, also known as stockbrokers or trading members, act on behalf of their clients and perform the vital functions that are transactions such as buying and selling stocks. For this, the brokers are paid a brokerage commission.
In addition to this, there are also a few other services that are offered by stock brokers. They can efficiently manage the portfolio and provide financial advice to their clients based on the market conditions and analysis.
Now that the transactions are also done online, the brokers also offer online platforms that facilitate trading for the investors and traders.
Before the dawn of the digital era, the brokers used to represent their clients on the exchange floor physically and execute orders are asked of by the clients. Registration of the stockbrokers with the exchange board is mandatory for all the brokers to perform their job legally.
Now that the times have changed in terms of technological advancement, the brokers, although still performing the same task, have been moved to a new stage – the digital platform.
What is the major function of a brokerage firm?
The following are the four major services carried out by a brokerage firm.
One of the main tasks of a brokerage firm is order execution. The brokers execute the client’s orders for a charge, called brokerage commission. This is either charged per transaction or a percentage of the transaction value.
Nowadays, thanks to the aforementioned digital dawn, all the major brokerage firms provide a digital trading platform that can be accessed by the client through any device like a smartphone or laptop. The transactions can even be carried out through chats.
The investors and traders depend on their stockbrokers for stock recommendations and this is true for both seasoned as well newbie investors. With this is bestowed a great responsibility on the brokers to be transparent with their clients and give them all the needed information including the risks.
Now that we understand the roles and responsibilities of a brokerage firm, let’s take a look at different types of brokers. Typically, there are three types of brokers. Let’s take a look at what they are.
Full-service brokers provide a very large spectrum of services to their clients. Most of the full-service brokers have their offices located in the major cities where they can meet clients in person and offer them their services.
Full service brokers have the bandwidth to offer customized support as well as tailored brokerage plans and services for their investors who may have different interests and varying levels of expertise. These brokers give the clients with large holdings the option to avail dedicated service managers to handle their portfolios.
Unlike the full-service brokers who can provide a whole catalog of services, the discount brokers focus only on the basics.
Discount brokers carry out the basic function of buy and sell orders for their clients and that’s where it ends. They do not offer any additional services to their clients.
That being said, the discount brokers also charge a much less commission as compared to the full-service brokers.
The Robo-advisors are automated digital platforms that can provide online financial planning services with the use of algorithms to suggest financial advise.
The Robo advisors require little to no human supervision.
How does it work?
When a trader or an investor signs up for a trading platform with Robo advisors, they are asked to fill up a survey stating their financial status and goals. Depending on that, the algorithm whips out financial advice that best suits the information provided.
Since there is very little human effort that goes into Robo-advisors, they tend to be cheaper than even discount brokers.
Demat and Trading Account
The two of the most important things that are mandatory to trade in the stock market is to have a Demat account and a trading account. we will look at what these are and how it is different from one another.
Let’s start with what a Demat account is.
In simple terms, a Demat is an account that lets you hold your shares in an electronic format.
In a Demat account, the physical shares are converted into an electronic form, thus dematerializing them. On opening a Demat account, the account holder is given a Demat account number, that enables the account holder to settle the trades electronically.
The functioning of a Demat account is quite similar to that of a bank account.
Like in your bank account, where we have the option to deposit and withdraw money, in the Demat account as well, the securities are held and accordingly debited and credited.
It is not mandatory to own any shares to open a Demat account. In fact, it is okay to even have zero balance in your account.
To be able to perform your stock trading activities, you will require a trading account.
When a company gets listed and its shares in the stock market open for trade, you can trade them on an electronic system through a special account, which is the trading account.
To open a trading account, register with a firm or a stockbroker. On opening the trading account, you will be assigned a unique trading ID which grants you access to make trades and transactions.
The difference between a Demat account and a trading account
- A trading account is used for the buying and selling of securities whereas, a Demat account keeps the financial instruments in an electronic format.
- A trading account functions just like a bank account whereas, a Demat account is a place or a location where the shares and securities owned by the account holder are stored in an electronic format.
Bull market vs Bear market
The bull market and bear market are the terms that we hear quite often in any topic relating to the stock market. Let’s learn in detail about what they are.
What is a bull market?
Bull markets are ideally the buyers’ market. It is known that consumer confidence greatly impacts the financial markets for stocks, bonds, and commodities
The bull markets occur when stock prices are on the rise for a sustained period. Propelled by the thriving economies and low unemployment that usually accompanies bull markets, that creates a market favorable for only potential buyers.
At this time, the investors are eager to start investing in securities, thus creating a buyer’s market.
What is a bear market?
The bull market, as we saw, is fueled by optimism. But sadly, the same cannot be said about the bear market.
Bear markets occur when stock prices fall 20% or more for a sustained period of time.
The bulls are in charge when there is economic strength, whereas bear markets often occur when there is an economic slowdown and higher unemployment. At this time, instead of wanting to buy into the market, the investors choose to sell stocks.
As a result, the sellers start trading and give us a seller’s market that may last for a few weeks to even years.
Bear vs Bull market
Any investor with a little interest in understanding how the stock market work knows that the markets are constantly in flux. Many times, it may not be even due to bear or bull markets.
In this market, even some small gains and losses can potentially offset each other, which will eventually lead to a flattened market. Along with that, markets can also experience more significant changes because of the short-term trends or market corrections that can cause the market to move in a downward direction.
Although bull and bear markets occur over a sustained period; the positive resulted posted have proven that over time, the bulls always prevail.
Bid & Ask/Offer Price
In security trading, the term bid and ask refers to the best-specified price that buyers and sellers in the stock market are willing to trade at. Or to put it in much simpler words, bid and ask price refers to the best price at which a security trading happens in the current time.
Let’s look at these terms separately.
What is the bid price?
This is the price that an investor is willing to pay for a particular stock. Only the bid price is also a representation that tells us of the highest market price that is offered for a stock.
What is the Ask price?
The Ask price is the price for which an investor is willing to sell the stock. The asking price usually represents the lowest price of a stock in the market.
While trying to understand the bid and ask prices, it is important to note that the current stock price is the price of the last trade, which is a historical price.
The difference between the bid and ask price is the bid-ask spread. This difference is considered as the cost of trading by the investors. Let’s look at it with the help of an example.
There is a company, A, whose current price quotation for their stock is x, and an investor who is looking to buy shares of A in the current market price is willing to pay y amount. The difference between the x and y amount is the bid-ask spread.
The bid-ask spread works in the favor of market makers and the spread is their profit.
Now that we live in times where digital technology is in the boom, many investors opt to buy and sell stocks by themselves instead of paying advisors a large commission to make trades.
But, before you decide to get into securities trading all by yourself, you must understand what different types of orders are when it is most appropriate to use them.
We’ll look at the different types of orders in detail in this segment.
A market order is an order to buy or sell equity shares or stocks immediately. This type of order guarantees the execution of the order but does not guarantee the execution price.
In general, a market order is executed at or near the current bid in case of a sell order or ask in case of a buy order price. Although, what is important for the investors to remember is that the last-traded price may not necessarily be the final price at which a market order will be executed.
When a time frame of expiry is not set for an order, then that order will be typically set as a day order. This means, at the end of the trading day, the order will be expired.
If the order isn’t transacted that day, then it will have to be re-entered on the following trading day.
A limit is an order to buy or sell a security or equity shares at a specific price or better. A buy limit order can only be executed at the specified limit price or lower, and a sell limit order can only be executed at a price set higher than the limit.
When the price of a stock reaches the stop price, a stop order becomes a market order.
A good-till-canceled order is a time restriction that you can be placed on different orders. A good-til-canceled order will remain active until the investor decides to cancel it. Typically brokerages keep a maximum time limit of ninety days where you can keep an order open or active.
In a long trade, you buy an asset, hold the asset, and wait to sell at a higher price and profit from the sale of the asset.
It is advised to go long or use a long trade on a stock that you believe or know will rise in price. When you see an opportunity to enter a trade, and you are sure that the stock price will increase, then you’d go long on that stock.
In short trade, the trader borrows the asset and then sells it. And then, the trader waits for the stock to hit a lower price in the securities market to buy it, make a profit and give it back to the lender.
It is advised to go short on a trade if you strongly believe that the price will drop low for the shares that you plan to buy.
Intraday trading refers to the buying and selling of stocks on the same day before the market closes. On failing to do so, the broker may square off your position, or convert it into a delivery trade. Whether a person is an experienced trader or a beginner, looking at the trends and indicators is always beneficial for intraday trading.
Intraday trading is performed not with an interest of investment, but with the motive to make a quick profit. Common technical analysis indicators that have proven to be helpful for traders are Moving Average, Bollinger Bands, Relative Strength Index, and Momentum Oscillators.
It is strongly advised to avoid volatile stocks. Traders should always look out for stocks that are correlated with major sectors. Research and following the trends also prove vital for a trader, whether a beginner or a professional.
Nifty & Sensex
Nifty is the collection of top 50 stocks that are listed under NSE. It’s the country’s most popular stock index. It was first founded in 1992 & became operational in 1994.
The Sensex is India’s benchmark stock index that represents over thirty of the country’s largest and most well-capitalized stocks as they are listed on the BSE. The index as we know it today was launched in 1986.
The index is float-adjusted as well as market-capitalization-weighted. The Sensex in India has grown since India opened up its economy in 1991.
The volatility of stocks describes when a market or security experiences certain periods of unpredictable, and sometimes sharp, price movements. While the term is mostly considered in relation to the price drop, it can also refer to the sudden rise in the price as well.
There are several ways to measure the volatility of stocks, including beta coefficients, option pricing models, and standard deviations of returns. Highly volatile stocks are often considered riskier than less volatile stocks as their prices are expected to be less predictable than usual.
The volatility of stocks is an important variable when it comes to calculating options prices.
The trading volume is a measure of the quantity of a given financial asset that has been traded in a period of time.
In the case of stocks, the volume is measured in the number of shares that were traded and, for futures and options, it is also based on how many contracts have changed hands.
Volume can be an indicator of market strength, as rising markets on increasing volume are typically viewed as strong and healthy. When the prices fall on increasing volume in the securities markets, that is a strong indicator of the downward trend.
When the price of the underlying stock reaches new highs on decreasing volume, it is an indicator of an impending reversal. On Balance Volume and Klinger Indicator are examples of charting tools that are based on volume.
The dividend yield is the annual dividend paid to shareholders that is an expression of a percentage of the stock’s current price. This number can potentially tell you what you can expect in future income stock can provide, based on the price you buy it for today and assuming that the dividend remains unchanged.
It’s important to know that the stock’s yield can change over time either in response to market fluctuations or as a result of dividend increases or decreases by the issuing company.
In essence, the stock yield is not set in stone. The dividend yield is most useful as a metric to help determine the stock valuation, to find stocks that are best suited for you, and to let you know that a dividend may be in trouble.
Let’s understand averaging down with an example.
Let’s say, a trader purchases an asset, the asset’s price drops. If the trader purchases more, it is referred to as averaging down. It is called averaging down because the average price of the asset has been lowered. Because of this, the point at which a trade can become profitable will also be lowered.
Is it a good idea to average down? That entirely depends on the situation. If the particular asset’s price improves, then the original trade has been increased in profitability and your average entry price has decreased.
If the asset’s price then drops, however, the original trade’s loss has been increased further. For this reason, the subject of whether averaging down is a viable strategy is divisive among traders.
Market capitalization refers to how much a company is worth as is determined by the stock market. Also popularly known as a market cap, it is defined as the total market value of all outstanding shares.
To calculate a company’s market cap, the number of outstanding shares are multiplied by the current market value of a single share.
The market cap is often used to describe a company, it still does not measure its equity value. That can be done only by a thorough analysis of a company’s fundamentals.
It is inadequate to value a company because the market price on which it is based does not necessarily reflect how much a piece of the business is worth, as shares are often over or undervalued in the market.
IPO/Initial Public Offering
IPO refers to the process of offering shares of a private corporation to the public in a new stock issuance. To issue stock to the public, the companies must first meet the requirements that are set by the Securities and Exchange Commission.
By opening IPOs the companies gain an opportunity to obtain capital by offering its shares to the public. Companies can hire investment banks to market, gauge demand, set the IPO price and date, and more.
An IPO can also be seen as an exit strategy for the company’s true founders and early investors, realizing the full profit from their private investment.
A portfolio is a collection of financial investments like stocks, bonds, commodities, cash, and cash equivalents, as well as their fund counterparts.
Stocks and bonds are generally considered as the portfolio’s core building blocks, though it is also possible to grow a portfolio with many different types of assets such as real estate, gold, paintings, and other art collectibles.
Diversification is a key concept in portfolio management.
A person’s tolerance for risk, investment objectives, and time horizon are all critical factors when assembling and adjusting an investment portfolio.
The terms discussed above are the basic stock market terms that a trader or an investor must understand before stepping into the market. By learning these terms and their meanings, it is easy for a beginner to read the market and analyze the market movements and make the maximum returns out of it.