Many people treat financial terms either as fancy words or the vocabulary of an unknown foreign language. If you're a newbie in the financial world, the chances are high that you may find language barriers. But referring the terms of the glossary will help you to fit in this world very quickly.
See below Basic Stock Market Terms explained in easy manner -
Arbitrage is the process of buying the financial assets at a lower price from one market and selling it at a higher price in another market, thereby taking advantage of the price difference between the two markets.
For example, the shares of the company ABC is trading at $100 in the cash market, and its future contract is trading at $120 at the same time. So an arbitrageur can purchase the shares from the cash segment and can sell it in the future market, thereby can make a profit of $20 per share in that particular stock. Arbitrage funds work in this way.
Assets are also called financial instruments and are intangible as well as liquid in nature. It’s nothing but an ownership contract having a value and can convert easily into cash on release.
They can be standard contracts with predetermined characteristics, or a tailor-made contract containing the customized agreements between the parties involved in it.
Derivative instruments and cash instruments are the two main classifications of the financial instrument. The value of the derivatives is derived from the value of the underlying assets like interest rates, indices, etc. In other words, we can say that the value of the derivatives come from the performance of the underlying asset.
The value of the cash instrument is determined directly by the market. Securities, deposits, loans, etc., are examples of cash instruments.
Depends upon their nature, financial instruments are again classified into equity-based financial instruments and debt-based financial instruments. Equity-based instruments are issued to its shareholders by a company for raising the fund for the business. While debt-instruments reflect a loan, the investor made to the issuing entity.
Offer price, asking price or ask is the lowest price that a seller is ready to sell a security.
Usually, ask price will be more than the current market price of the shares. So the person who is looking to buy those shares needs to pay more while purchasing.
Suppose, Ms.S wants to buy the shares of XYZ company, which is trading at a market price of $20. But the lowest price that the sellers are offering is $22. So if she wants to buy those shares at that moment, then she has to pay $22, which is called the ask price.
A balance sheet is the summarized statement that shows the financial position of a company for a given point of time. It shows the details of the company’s assets, liabilities, and equity.
A balance sheet has two parts. In the left part of the balance sheet contains details of the assets and in the right section, the liabilities and equity.
It’s based on the equation Asset = Liabilities + Equity.
The assets column shows all those resources and things that the company owns. Assets are classified as liquid assets (cash or can be converted easily into cash) or non-liquid assets (can't convert into cash easily) like land, buildings, etc. Assets also contain intangible assets like patents, copyrights, etc. which are very difficult to value.
The liability column shows the debts and liabilities of the company. It can be broken down into current liabilities and long-term liabilities. Current liabilities are those due within 12 months like wages, interest payable, rents, etc. Long-term liabilities are due after one year and include long-term debts, deferred tax liabilities, etc.
Balance sheets are made in every quarter or after the end of the financial year.
A portfolio that has different types of assets like stocks, bonds, mutual funds, etc. is called a balanced portfolio. Investing all your money in one asset means putting all your eggs in one basket i.e., a risky business.
So a balance portfolio emphasis on parking your money in different types of assets. By having a diversified portfolio, you can take advantage of the different economic cycles as different assets move in different cycles.
A period of time in which the prices of various assets witness a downfall is called a bear market. During this period, the market price of the assets constantly shows significant volatility. In a bear market, the investor sentiments start declining and as a result, the securities witness massive selling. It can cause a further decline in the price of the securities and significant losses in the index.
The economic slowdown is the root cause of a bear market. The high unemployment rate and lower consumer spending are its characteristics.
A bear market followed after the housing bubble of 2006.
The beta of a stock shows the volatility of the stock to the up/downswings in the market. A high-beta stock has high-risk. Always keep in mind that the higher the risk, the higher the return.
For example, if a stock has beta value 1, then the stock is considered as more volatile than the market, and those with beta value 1 is expected to show the volatility in line with the market.
Bid Price is just the opposite of Ask price and defines as the highest price that a buyer is ready to buy a security. Usually, the bid price will be less than the ask price.
Suppose a person wants to buy X no. of shares of a particular company, which is trading between $50 and $55. But the person is not ready to pay more than $53 to acquire that stock. So he set a limit order at $53 for X no. of shares and this is called the bid price.
The stocks of a larger company with good corporate governance, outstanding financial performance, and a brilliant management team. It’s got this name from the blue-chips of the poker games.
The shares of Microsoft, Apple, Facebook, etc. are examples of a few blue-chip stocks.
A financial instrument that carries an interest (coupon) and has a maturity date. Bond is classified as a debt instrument and is an integral part of a diversified portfolio.
There are four major types of bonds in the US markets and they are corporate bonds, treasury bonds, agency bonds, and municipal bonds.
Book value is the value of the company’s asset expressed on the balance sheet. Book value per share used to measure whether a share is overvalued or not and it can be calculated from the following formula:
Book Value per Share = Total Shareholders’ Equity / Total no. of Outstanding Share
Brokerage is the commission/fees paying to the broker for executing a trade. A broker is a person or a firm who buys/sells the stocks on behalf of the investors and charges a commission for executing the trades.
Opposite of Bear Market. A period of time in which the prices of various assets are in the upswing. A bull market is also an indication of a sound economy.
In a bull market, the prices of shares make higher highs and higher lows.
Purchasing a financial instrument is called buying. While buying the shares of the company, the investor gets fractional ownership of the company and along with this, the investor will be entitled to get voting right, a fraction of the company’s earnings, etc.
A type of chart used in the technical analysis and shows the relation between the opening and closing prices. It’s three main components an upper shadow, a lower shadow (tail), and a real body.
If the closing price is above the opening price, the color of the body will be white and else it’ll be black.
Capital gain is nothing but the profit earned on the sale of an assetand capital loss is just the reverse of capital gain.
Capital Gain/loss= (sales price* no. of shares) - (original cost*no. of shares)
As capital gain comes under income, it carries tax. Capital gain tax can be either short term or long term. Short term capital gain tax is applicable for assets held for one year or less and taxed as per the ordinary income tax rate of the investor.
On the other hand, Long term capital gain tax is applicable for assets held for more than 12 months and taxed at a lower rate than the short term capital gain taxes.
The examples of taxable assets are stocks, bonds, etc.
A place to trade different intangible assets like stocks, bonds, etc. NYSE and NASDAQ are famous capital markets of the U.S.
In the capital market, the buying and selling undertaken by the market participants. The capital market is the best source of finance for companies. For investors, it offers a range of investment avenues. The capital market helps the investor to get access to high-quality information regarding investments.
The capital market has two components
- The primary market
- The secondary market.
Another important classification of the capital market is based on the nature of securities traded, i.e., stock market, bond market, etc.
Cash flow is a statement that shows the in and outflow of the money for a particular period in business. It shows cash flows mainly from three activities
- from operating activities
- from investing activities
- from financing activities.
A commodity exchange is a regulated market to trade physical assets like food, metals, grains, etc. NYMEX, New York, and LME, London are two famous commodity exchanges.
These markets allow commodity trading using futures contracts as well. Usually, the buyers of these contracts agree to pay the agreed-upon sum at the time of the transaction when the seller delivers the commodity at a pre-decided date in the future.
The main participants of commodity exchanges are the producers, the speculators, the industrial end-users, and the traders.
The process of earning interest on interest as well as the initial principal is called compounding.
For example, Ms.Z is investing $20,000 at an interest of 8% for three years. Then at the end of the first year, the interest earned on $20,000 will be $1,600 and the principal for the second year will be interest+ the initial principal i.e., $20,000+$1,600=$21,600
The coupon rate is nothing but the interest rate on fixed income security. The interest is based on the yield as on the issue day of the security. Treasury bills, bonds, certificate of deposits, etc. are examples of fixed income securities.
Coupon= Coupon Rate X Par Value
Current assets appear in the balance sheet of a company. It represents the short term assets that can be converted into cash easily as well as is expected to consume in the next 12 months from the date of the balance sheet.
Examples: Bank balance, stocks, inventories, prepaid expenses, etc.
Current liabilities are those liabilities/debts that are due to be paid within the next 12 months. It’s part of the balance sheet.
Examples: Accounts payable, dividends payable, income tax payables etc.
Shares whose price performance has a significant dependency on the overall economy. Their price will be in an upswing when the economy is doing well and will be in a downswing when the economy slows down.
Examples: The shares of the companies of the hospitality sector, agriculture sector, etc.
Day orders are orders to buy or sell an asset and placed for execution just for one trading session. If not executed till the end of the session, then it cancels automatically.
Unless the investor specifies a time frame for the expiration of an order, orders to buy and sell stocks are day orders (they are good only during that trading day).
A day order is one of the several types of orders that represent timing instructions. Other duration type orders are Good-Till-canceled (GTC) and Immediate-Or-Cancel.
Debentures are a debt instrument issued by large companies to raise money for medium to long term and they carry a specific interest rate and have a maturity period. Debentures can be convertible or non-convertible.
Convertible debentures can be converted into equity shares after a pre-determined period while non-convertible can’t.
Debt-equity ratio is a measure of the firm’s use of fixed-cost financing sources. There are two ways that a company finances its capital requirements- either through debt or through equity.
D/E ratio tells us how much debt the company uses compared to its equity. A lower value shows that the company uses a lower amount of financing through debt and a higher one shows that the company is borrowing more.
And a higher level of borrowing indicates a greater chance for bankruptcy during tough times. It’s always recommended to compare the D/E ratio of the companies of the same industries because this value varies from industry to industry.
D/E = (Short term debt+ Long term debt+ Other fixed payments)/ Total shareholder’s equity
|D-E Ratio (x)
A failure to pay the debt on time is called default. While taking a debt, you need to sign a legal contract to pay the interest as well as the principle on time. On default, you may face a lawsuit.
These stocks are less risky and less exposed to the business cycle. They’ve got a strong track record of paying dividend and reporting excellent earnings. Shares of the companies that sell drugs and food are examples of defensive stocks.
Delisting is the process of removing the listed securities/shares of a company from a stock exchange where it trades regularly. The reasons for de-listing may be different.
- The company is no longer meeting the listed requirements or
- going into liquidation. Delisting can either be a voluntarily delisting or compulsorily delisting.
Depreciation is a non-cash expense and appears in the income statement of a company. It’s the drop in the market value of a fixed asset due to wear and tear or age or weather.
A derivative is a contract whose price is derived from an underlying asset. The underlying asset can be the currency, stock, or a market index. Various types of basic contracts are forwards, futures, options, and swaps.
Diversification is a portfolio strategy that aims to reduce the risk by selecting the right investment tools in the right proportion and thereby generate higher returns.
In terms of the business of a company, diversification refers to a corporate strategy to foray into a new business segment or a new geography.
Divesting is the opposite of investing. It’s the act of selling-off an assets/investments or parts of a company. The term is often expressed to describe when a company or a government sells some of their holdings in a company.
For example, ABC, a financial service company, is a subsidiary of XYZ, a diversified company. For some reason, if XYZ wants to sell ABC, then it may divest that business by selling all the assets of ABC to another company.
The dividend is the part of the profit that a company pays to its shareholders. Interim dividend and final dividend are the two types of dividends. If the company announces and pays the dividend before issuing the annual financial statement, then it's called interim dividend.
The final dividend will be paid only after the issue of the annual financial statement for the fiscal.
Dividend per share (DPS) = Total dividend paid / Outstanding no. of shares
Dividend Yield measures the amount of cash dividends paid out to the shareholders relative to the market value per share.
Dividend Yield = Annual Dividend / Stock Price
Suppose a company ABC pays an annual dividend of $1.50 per share. If the current stock price is $15, then the dividend yield of the company ABC =$1.5/$15 = 0.10= 10%
Dollar-Cost Averaging is an investment principle of investing a fixed amount systematically in a particular investment for a period to build the wealth in the portfolio.
This helps the investors to purchase more shares when the prices are down and less when the prices are more.
For example, on a particular date of every month, you’re investing $1,000 in a company. In the first month, if the price is $20 per share then, you'll get 50 shares. In the second month, if the price is at $10 per share, then you'll get 100 shares.
Earnings per Share (EPS) indicate the profitability of the company. EPS is the portion of a company's profit assigned to each share of stock.
EPS= Profit After Tax (PAT) / Total no. of Outstanding Shares
Equity is nothing but the net amount of funds that the owners have invested in the business plus any retained earnings.
Equity = Assets - Liabilities
Equity can also refer to the ownership that an individual gets in an asset.
Suppose Mr. X owns a house worth $ 800,000 and owes $200,000 as the amount of mortgage. Then the equity in the house = $800,000-$200,000=$600,000
Exchange-Traded Funds (ETFs) is a marketable security that tracks an index like an index fund. Investing in ETF is an easy way to diversify the portfolio.
Unlike mutual funds, ETFs are traded like stocks in the exchanges.
Fundamental analysis is a method to value a stock i.e., to determine whether a stock is overvalued or undervalued, using economic factors.
It mainly focuses on the financial statements of the company and is suitable for a long-term investment approach.
A growth stock is one that has the prospect of growing at a rate higher than the stock market. They carry average or above-average risk.
When an investor buys a growth stock, he/she assumes that the good earning record of this stock will continue over the long-term.
Price/Book Value Ratio compares the market price and the book value of a company. This ratio shows how much an investor is paying for each dollar in the net assets. Since it's multiple, a lower value is considered as good.
Usually, a value under 1 is considered as good. It signals the stock is undervalued. A greater P/BV (more than 1) shows that the market price of the company is higher than its book value.
While buying stocks having higher P/BV, the investor is paying a premium above the book value and expects the company will generate enough earnings in the future.
P/BV= Price per Share / Book Value per Share
Price/Earnings Ratio is the most widely used ratio and can be calculated by dividing the stock price by the earning per share (EPS) of the previous financial year.
It indicates how much the investors are willing to pay for every dollar of earning. It's expressed as a multiple, so stocks with a lower P/E ratio are considered superior.
Shares with a low P/E ratio indicate that the stock has experienced superior results relative to the market and at the same time, it's undervalued. So, investors can buy undervalued stocks at a discount and when the price moves-up, they can book the profit.
Comparing a company's P/E with its peers will give a sense of whether it's overvalued or undervalued.
P/E = Current Market Price / EPS
Return on Equity (ROE)
ROE shows how much profit the firm generates for each dollar of equity it owns, or in other words, ROE shows how effectively the company is using its assets to generate profits.
This ratio never tells us whether a stock is cheap or expensive; instead, it says only the profitability of the firm. This ratio depends a lot on the firm's debt level i.e., higher the level of liabilities, lower the shareholders' equity, and higher the return on equity.
ROE = Net Income / Shareholder’s Equity
Risk is the uncertainty associated with an investment and as a result of the risk, the actual return of the investment will be lower than the expected return.
Systematic risks and unsystematic risks are two different types of financial risks.
The method of evaluating the securities by studying price, volume, and open interest. Technical Analysis requires an understanding of the chart patterns and technical indicators.
Good-Till-Canceled (GTC) orders are limit orders to buy/sell security. It remains in place until the order is canceled or the trade is executed.
But, usually, brokerage firms limit the time an investor can keep a GTC order open and it varies from one broker to another.
Inflation is the rapid rise in the price of goods and services. As a result, the general price level in the economy increases and reduces the purchasing power of the people.
A high level of inflation leads to lower international competitiveness i.e.; exports will be less if the inflation will be higher.
Inflation leads to a decline in the value of money, but at the same time, it helps the prices to adjust and goods to attain their real price.
A moderate rate (5% is considered as the breakpoint of moderate inflation) of inflation augment the stability of the economy and reduces the actual level of the debt.
Immediate or Cancel (IOC) orders allow the investor to buy/sell the securities. It executed as soon as the order is released into the system if the price conditions are matched.
If the orders can’t execute immediately, then soon it will be canceled.
A limit order is used to execute trades at a specific price or better. Sell limit and buy limit are two different types of limit orders.
A sell limit order is executed only at the specified price or higher, while a buy limit order is executed only at the specified price or below.
For example, if an investor wants to buy the stocks of a company at $15 per share and not willing to pay more than that. In such a case, the investor can place a limit order that will execute only if the price of the stocks reaches $15 or below.
A market order allows the investor to buy/sell the securities at the best available price. Usually, they are executed immediately, so market orders tend to result in unfavorable fill prices.
The investor must remember the last-traded price because the price at which market orders execute often deviate from the last-traded price. If the order is a large market order, then it can be executed at different prices due to the fast-moving property of today’s markets.
Suppose an investor places an order to buy ‘x’ no. of shares of a company at $10. Chances are there that these orders may be executed at a higher price because other orders are executed first.
At the same time, if it's a large order, then a part of it'll be executed at $10, and the rest will be executed at a higher price.
Moving average is the average price of a stock or market over a defined period. A 200-day moving average is used to determine the long-term trend.
It's one of the most popular tools used in technical analysis. It smoothes out short-term data series to make the trend more clear.
Open interest is nothing but the total number of outstanding unsettled derivative contracts at the end of each day. It's a measure of the overall level of activity in the futures market.
Increasing open interest shows money is flowing into the market and a decline shows the current market is going to end soon.
Overbought and Oversold
Overbought and oversold are two terms associated with momentum, which suggests that too much stock has been bought or sold. They mean that the market has moved too far, too fast, and the trend can't be sustained.
An overbought stock may be trading at a price much higher than its fair value and an oversold stock may be trading at a much lower level than its fair value.
Overbought is an indication of a pullback and oversold shows a price bounce is on the card.
Oversubscribed is a term associated with the primary market. An IPO of a company is said to be oversubscribed when the demand for the shares is more than the total no. of shares issued by that company.
The level of oversubscription is expressed in terms of multiples. For example, the IPO of XYZ has oversubscribed three-time shows that the demand for the shares of that company is three times more than the scheduled issues.
Primary market is part of financial market. It’s the market for new issues of securities/bonds, or in other words, it's the place where the companies issue new securities in exchange for cash from the investors.
An essential characteristic of the primary market is that here, the securities are purchased directly from the issuer.
During the process of the initial public offer (IPO), the company sells the shares directly to the investors through the primary market.
The secondary market is the place to resale/trade the shares that an investor had purchased from the primary market.
To be more precise, it’s the market where securities are traded after being initially offered to the common investors in the primary market or listed in the stock exchange.
After the IPO process, the stocks get listed in the exchange and are traded in the secondary market. Here an investor purchases the shares from another investor who is ready to sell the same.
The Secondary market consists of the equity market and the debt market.
Shareholder’s equity is the amount of assets that the investors own after all the debts are paid off. It’s the difference between the company’s asset and liabilities and is part of the balance sheet.
Shareholder’s equity = Asset - Liabilities
Shareholder’s equity has two parts
- Paid-up capital
- Retained earnings
Paid-up capital is the amount that the company received from the investors for their shares of stock.
Retained earnings are nothing but the profit that the company has accumulated over time after paying the dividend.
Short selling or short is the betting in the opposite direction of the market with the hope that the prices may decline soon.
In this technique, the investors sell the stock first and then buy them back at a lower price, thereby making a profit. It's an essential feature in the stock market not only for providing liquidity but also for the correction of overpriced stocks.
Short selling is a risky affair because there is no limit to the amount you can lose if the stock continues its upward journey even after you short it.
Avoid shorting illiquid stocks because it's difficult to get out of a position in an illiquid stock.
Spread or bid-ask spread is the difference between the lowest ask and the highest bid of the stocks, bond, or commodity i.e., the difference between the buying price and the selling price.
Spread= Ask Price – Bid Price
Speculative stocks are stocks issued by a firm without a proven financial status and at the same time, expected to have good potential for sustainable price appreciation soon on the back of some special situation.
The beta of these stocks will be very high, so they carry a very higher risk as well as the stock price witnesses a wide up and down swings.
Examples of speculative stocks are the share of animation and media companies.
Stop order or stop-loss order is executed only if the market price reaches a specific price called stop price. On reaching the stop price, the stop order becomes a market order.
There are buy stop orders and sell stop orders. Usually, investors use a buy stop order to limit their losses in a particular stock that they’ve already shorted. In a buy stop order, the stop price should be above the current market price.
Investors use a sell stop order to protect their profit in a particular stock that they’ve already bought. In a sell stop order, the stop price should be below the current market price.
Support and Resistance
Support and resistance are standard terms used in the technical analysis and shows the price levels at which the price stops moving down or going further up.
If bulls think that the price is low, they try to buy, and due to the strong demand, the price will move up. When the price starts rising, the bulls become less aggressive and the bear becomes more aggressive.
At some point, this aggressiveness will balance and that price level becomes resistance.
On the other hand, when the aggressiveness of the bear falls, that of the bull rises and the point at which they balance is called support.
All markets remember the previous support and resistance levels, which can be used as target or limit prices when the markets have traded away from them i.e., if a rally ended before a year ago, the top of the rally becomes resistance for the next rally.
Stocks with unusually low prices in relation to the company's earnings are called value stocks. These stocks have the potential to report higher growth.
Value stock can also be described as an investment strategy to buy good shares at a cheaper price.
Another positive about the value stock is that they’ve less chance to go down further as they’re already undervalued.
The value stocks often remain undervalued for a particular time only, but in rare cases, they get into value traps and may remain there for an extended period.
Volume or trading volume shows the total no. of shares traded at a particular time. It’s the pillar of technical analysis and shows the best entry and exit points.
The volume includes concepts such as accumulation and distribution, market breadth, open interest, and trade count.
You can see a higher volume growth with the release of positive stock-specific news and in a bull market.
While counting the volume, each buy or sell transaction is counted only one. For example, if an investor sells 100 shares of a company and another investor buys these 100 shares, then the volume is counted as 100 and not 200.
Volatility is the measure of the risk and shows the range and speed of the price movement.
A stock is said to be highly volatile if its price undergoes significant changes over a short period. To check the volatility of a stock, you can check the beta of security.
Investors with low risk-appetite should avoid high volatile stocks due to the uncertainty associated with them.
Stay tuned for stock market glossary terms. This page is updated regularly for new terms.