If you are a newbie in the stock market then it is very easy to get overwhelmed by the uncountable number of stock market terms. This post will give every stock market beginner a head-start with the most important financial terms. In case you have no idea which stock market terms to know before beginning to put your hard-earned money in the stock market, then this is the right post for you.
So, let’s get started with the essential stock market terms.
The word ‘stock’ is interchangeably used with the word ‘share’, though there is a slight difference. Let me give you a simple statement for understanding the difference: “Mr.XYZ has bought 50 shares of ABC Company’s stock.”
Shares refer to certificates which represent ownership in a company. So, if you own shares of any company you have a claim to its income and assets, equivalent to the fraction of shares you hold. But you carry an equivalent proportion of the risk as well, in case the company goes bankrupt.
2> Stock Symbol
Every stock has its own “stock symbol” (also called “ticker symbol”). Whenever you want to purchase shares of a particular stock you can get the price quote by typing in the stock symbol in your trading terminal or app. For example, the stock symbol for “State Bank of India is “SBIN” and for “Bank of Baroda” is “BANKBARODA”.
Sometimes it may be confusing to find a particular stock by its stock symbol if you don’t know what the symbol is. In this case, you can do a google search first with the company name to get the symbol for the stock.
One such stock for me was “Reliance Communications”. I started typing “REL…” and what came up was “RELIANCE”. But later I came to know that “RELIANCE” was the symbol for “Reliance Industries” and not “Reliance Communications. The correct symbol for “Reliance Communications” is “RCOM”. So be alert while selecting the stock symbol for the first time.
3> Stock Broker
A Stockbroker is a financial intermediary. His work is to ease the execution of orders (for buying or selling shares) between you and the stock exchange through a trading account. For this, you need to have a trading account with the broker.
While choosing a broker it is essential to check the brokerage fees and the type of service (Full-time Broker or Discount Broker) that you expect from him. Brokerage fees have a much more significant impact on Intraday traders than it has on Long-term investors. So if you are planning to go for Intraday trading (or even Short-term trading) it’s very crucial for you to check the brokerage fees before you open a trading account with any broker.
In case you don’t want to spend time on evaluating stocks yourself you should go for a Full-time broker. They will suggest you the stocks you can buy. But if you have confidence in your own market analysis you can opt for a Discount Broker and trade on your own through a trading account (this is what I do). For this reason, Discount Brokers charge lower fees compared to Full-time brokers. You can really save some serious amount of money just by choosing the right broker.
4> Stock Exchange
The stock exchange is a common marketplace where buyers and sellers meet to transact shares. You might be thinking “I have never seen any market selling shares!”. This is because now everything happens electronically. With the click of a button you can buy shares worth lakhs of rupees and you won’t even know who sold the shares to you from which part of the nation. The stock exchange takes care of all this so that you don’t have the trouble of finding a seller when you want to buy a stock or vice versa.
You can’t directly transact in the stock exchange. You need to place your orders through a financial intermediary (like a Stockbroker) to do the transaction.
5> Reward-to-Risk ratio
It is one of the stock market terms which is under-estimated by new traders. But it has a significant impact on your money. As I have already mentioned in my previous post (In case you haven’t read it, here is the link: Benefits and Risks of Investing), risk management should always be a top priority. But making a profit is also equally important. This ratio helps you understand the amount of risk you will need to take to get a particular amount of profit. This ratio should be preferably 2:1 (Reward : Risk) or more.
6> Capital Gain
Suppose, you buy a share today and the price of that share increases over time. This increase in the price of the share is the capital gain. This capital gain will be realized only when you sell the share. If you sell the share before completing 365 days after acquiring it, you will have ‘short-term capital gain’ (STCG). But if you sell the share after holding it for more than 365 days, you will have ‘long-term capital gain’ (LTCG).
Depending on the type of capital gain you will have different tax implications. We will cover the tax related issues of the stock market in another post.
It is a request that you place in the stock exchange through your broker using a trading account, to either buy or sell any financial instrument. Order types vary depending on your requirements. Two of the most primary order types are ‘Market Order’ and ‘Limit Order’. ‘Bracket Order’ and ‘Cover Order’ are two more complex order types.
If you are price sensitive and want to buy a stock at or below a particular price then you should use a limit order. But if getting the stock is more important and it doesn’t matter at what price the stock is currently selling in the market, you should use a market order.
There are several other order types like ‘After Market Order‘, ‘Pre-Market Order’ and ‘Post-Market Order’ and each of them have their own advantages and disadvantages.
Different order types are discussed in detail in separate posts. I have provided three links below for your ease.
When a publicly listed company makes a profit, it may decide to distribute a portion of that profit to the shareholders. It can do so by paying dividends in the form of cash (cash dividends) or stocks (stock dividends). Paying out dividends is a way to ensure that the investors are rewarded so that they keep their money invested in the company. Companies that pay regular and consistent dividends to their investors attract new investors as well.
If regular ‘cash inflow’ (supply of money to your bank account, i.e. passive income) is more important for you than one-time capital gain, then good dividend paying stocks (with a history of consistent dividend payments) should be your choice.
9> Market Correction
Whenever the price of a share rises or falls too much, the price corrects itself by moving in the opposite direction for a short duration, just to grab back its strength. After that, it again continues to move in its original direction. This short-term drop in prices of financial instruments is a market correction.
Volatility refers to the degree of fluctuation of a financial instrument’s (stocks, bonds, futures, options, etc.) price. The more the variation in price the more the volatility.
So, is volatility good or bad?
The answer depends on what type of financial player you are. In case you want to avoid risk, you can’t make much friendship with volatility. But if you are a risk-taker, volatility can be your best friend.
Volatility also depends on the time-frame you are using to trade. A stock which looks very volatile on a 1-min chart may not be so much volatile on a 1-day chart. Usually, the shorter the time-frame, the more volatile the stock seems. There are also several technical indicators to check volatility (my favourite is ‘Bollinger Bands’).
11> Demat Account
A Demat Account is a must for holding any shares you purchase. Demat stands for dematerialized. Earlier, investors held share certificates in physical paper form. But now share certificates are dematerialized into electronic formats and stored in Demat accounts. Any share that you buy through your trading account will be stored electronically in your Demat account.
Currently, in India, all the Demat accounts are maintained by only two Depositories – ‘National Securities Depository Limited‘ (NSDL) and ‘Central Depository Services Limited‘ (CDSL). You can open a Demat account only through a depository participant (like a stock broker). You can’t do it directly with the depository.
Let me give you a simple analogy for clear understanding:
Shares ‘is like’ Cash.
Demat Account ‘is like’ Savings Account.
Depository ‘is like’ Bank.
So, you keep the shares you buy in a Demat account which is maintained by a depository. The only difference is that you can’t buy/sell shares directly. You have to do it through a depository participant, like a stock broker.
12> Trading Account
A Trading Account is a like a portal through which you place your buy/sell orders on the stock exchange. You can open a trading account with a depository participant (in most cases it’s the stock broker). As stated earlier, you can’t directly transact shares with the depository. So, a Trading Account is also a must for you if you want to participate in stock market transactions.
Most often, if it’s the first time you are opening a trading account then your broker will give you the option to open a Demat account as well. My broker simplified this account opening process for me. Yes, you have to do some paperwork, but it’s simple. It’s not as complicated as you think. I know a few people who avoid the stock market just because they assume that a lot of paperwork is necessary for investing or trading in stocks!
An index is a measure of something. Similarly, a stock market index is a measure of the stock market. You must be thinking “What a useless explanation this guy has given!”. Well then, let me elaborate it a little more.
A stock market index is made up of weighted-average of some selected stocks from different sectors. These stocks are chosen carefully based on certain factors like liquidity, float-adjusted market capitalization, float, domicile, eligible securities and other variables. These terms are just for your information. There is no need to worry about them too much in the beginning.
Since an index consists of different stocks from diverse sectors like automobile, IT, pharmaceutical, metal, bank, etc., it represents the overall scenario of the entire economy.
Currently, the two main market indices in India are ‘CNX NIFTY’ and “BSE SENSEX’. Some other popular indices are ‘DJI’ and ‘S&P 500’ in the US, ‘NIKKEI 225’ in Japan, ‘DAX’ in Germany, ‘Hang Seng’ in Hong Kong, ‘MICEX’ in Russia and ‘SSEC’ in China.
One last thing to note is that an index can not be traded like a regular stock. They are traded in the form of ‘derivatives’ (this term is explained later in this post).
In the field of stock market trading, margin refers to the minimum amount you need to have in your trading account to carry out a transaction, without paying the full amount which is actually needed for the transaction. So, if you have a margin trading account you can trade with money borrowed from your broker. Let me explain that with a very simple example.
Suppose you want to buy 10 shares of a particular stock, where each share is currently trading at Rs.50
So, the full amount which is actually needed for the transaction (in this case, buying) is Rs.50X10 = Rs.500
But if you have a margin account and your broker is providing you 20 times advantage (the financial market jargon for this is “20X leverage”), then the amount you need to complete the same transaction is
(Rs.50X10)/20 = Rs.25
In the financial world, margin actually refers to the ‘margining of risk’. So, volatility has a major contribution in margin calculation. More the volatility more will be the margin. Moreover, calculation of margin varies with different financial instruments (like shares, options, futures, currencies, etc.) and with different order types (like Bracket Order, Market Order, etc.).
A derivative is a financial instrument (like options and futures) whose value is dependent on another financial instrument (like stocks and bonds). The financial instrument on which the value of the derivative depends is known as the ‘underlying asset’. Stocks, bonds, currencies, commodities, interest rates, and even an index can be the underlying asset.
Derivatives are used mainly for 3 reasons:
As an ‘insurance’ to protect the underlying asset from risks.
Risks like sudden price drop of the asset due to some reason (like poor quarterly earnings report, interest rate changes, some big event like Brexit, etc.). This insuring of assets against risk is known as ‘Hedging’.
As a financial instrument for ‘speculation’.
Speculation is basically betting on the future price movement of the underlying asset. It is not like betting in a casino where you don’t have any idea where the dice will stop rolling. Speculation in the stock market has logic and reasoning in the backdrop. But even then some uncertainty will always be there regarding the direction of price movement.
As a ‘leverage’ for increasing returns.
A derivative is a contract which lets you control multiple units of the underlying asset. The ‘lot size’ (in India) decides the number of underlying asset units you can control using one derivative contract. In the United States, the number of units is 100 per contract (for futures and options contract) and is fixed. But in India, the lot size is different for different stocks and even the lot size for a particular stock may be changed with a prior notice from the stock exchange.
Let us assume an imaginary company named ‘ABC company’ whose stock symbol is ‘ABC’. If the lot size of ABC is 5000 and if you buy one future contract of ABC, then you will have control over 5000 shares of ABC stock.
A word of caution here: Whenever you use leverage to gain more profit, the chances of suffering more loss increases simultaneously.
Having said that, if you are educated well enough about the financial markets then the chances of suffering losses will be less than if you are not educated.
16> Bull Market
The Bull Market and the Bear Market are financial jargons referring to the overall outlook for the markets (stocks, bonds, commodities, etc.).
A bull attacks its opponent by thrusting ‘up’ its horns. So, a bull market denotes a market which is going up. This situation occurs when the investors are optimistic and the overall public sentiment is positive causing an upward movement of stock prices.
17> Bear Market
Just the inverse of the bull market is the bear market. A bear attacks its prey by coming ‘down’ on it with its paws from the top. So, a bear market denotes a market which is going down. During this market condition, the investors become pessimistic. The prices of financial assets move in a downward direction.
18> Intraday Trading
Intraday Trading, also popularly known as ‘Day Trading’, is a trading technique where you ‘buy and sell’ or ‘sell and buy’ within the same day.
There are a few reasons why more and more people are getting attracted towards this method of trading in the stock markets. I have listed a few reasons below:
- You can get very high leverage for a transaction of financial instruments (the leverage depends on your broker, the type of financial instrument and the order type.)
- If you are unwilling to carry forward your position to the next day for whatever reason it may be.
- When you want to get in and out of your trade quickly.
This may seem to be just a normal English word but you will come across this stock market term very often.
The type of transaction that we are familiar with in our normal day-to-day life is to ‘buy something first and then sell it (assuming that we are buying that thing for selling purpose only and not for our own use).
We do such a transaction when we predict that the price of an item is going to increase after some time. So we buy that item and hold till the price increases, and then sell it. The financial market jargon for such type of transaction is ‘Long’.
Let me help you understand this with an example.
Suppose the shares of a stock are currently trading at Rs.100 and I predict that it will rise to Rs.110 in some time. So I will ‘go long’ on this stock by buying the shares at Rs.100 and holding them till it reaches Rs.110. When it will reach Rs.110, I will sell them.
‘Short’ is the single term which can change your entire perception of the stock market. This is exactly opposite of ‘Long’.
When you ‘sell something first and then later buy it back’ you are actually going ‘Short’ (also called ‘Shorting’ or ‘Short-Selling’). Shorting is different from selling in the sense that to sell something you need to buy it first. But to short an item, you don’t need to buy it first.
We are not so accustomed to this type of transaction in our day-to-day life, but in the stock market, this technique can come very handy during a bear market, a market correction or a single stock whose price is falling.
Shorting is possible in the stock market because of your broker. Your broker lends you shares to sell them first. But it’s your obligation to buy back those shares and give them back to your broker in time. For now, let’s just understand the concept instead of getting into the minutiae of how it happens.
Suppose the shares of a stock are currently trading at Rs.100 and I predict that it will fall to Rs.90 in some time. So, I will ‘borrow’ shares of that stock from my broker and sell them in the market at Rs.100. Notice that I have not yet paid my broker. Later when the stock price will fall to Rs.90, I will buy those shares from the market at Rs.90 and return them to my broker. So, I will make a profit of (Rs.100- Rs.90) = Rs.10 (not considering broker charges here for simplicity).
This is one of the stock market terms that can save you a lot of money. The term is self-explanatory. Stoploss is the maximum loss at which you want to stop from continuing your trade any further. In other words, it’s the maximum loss you are willing to take before exiting from a trade. Let’s simplify this with a very simple example.
Suppose, you have bought a share at Rs.100 and the maximum loss that you are willing to take on this trade or investment is Rs.5. So, you will place your stop-loss at (Rs.100 – Rs.5) = Rs.95.
If the share price falls down to Rs.95, then your stop-loss will get triggered and the share will be sold. This way you can save yourself from any more loss if the price falls further.
There is a more sophisticated form of stop-loss called the ‘trailing stop-loss’. Using this you can not only cap your losses but also lock-in profits if the price increases.
If you are using an online trading platform, you can fill the “Stop-loss” field to place the stop-loss.
22> Chart Patterns
Charting is a very popular technique using which you can predict the possible direction of price movement using prominent patterns that can form on any price chart. These patterns are mainly dependent on ‘Support’ and ‘Resistance’ levels. Recognizing chart patterns is a vital skill every technical trader should gain.
Some of the popular chart patterns are ‘Double Top’, ‘Double Bottom’, ‘Head & Shoulders’, ‘Channels’ and ‘Triangles’.
Although technical traders use chart patterns on a regular basis, fundamental investors can also benefit from them for profitable entry and exit.
There are a lot of popular books on chart patterns, but my favourite is “Encyclopedia of Chart Patterns” by Thomas Bulkowski. Yes, you will definitely get a lot of websites with the free demonstration of different chart patterns. But none can tell you the success or failure percentages of each chart pattern, their identification guidelines and how to trade them. This is why I refer to this book for trading any chart pattern.
Apart from chart patterns, ‘Technical Indicators’ give traders an extra edge by measuring volatility and momentum, and predicting trends and direction of price movements.
Some of the most popular indicators are Volume, MACD (Moving Average Convergence Divergence), RSI (Relative Strength Index) and ADX (Average Directional Index).
Though technical indicators are not always correct, but they can improve your chances of profiting from a trade.
I have tried to keep the list as small as possible. There are many other stock market terms that are necessary for a beginner to know. But the above-discussed terms will surely help you get started.
Is there any term that you would like me to add to this list?
Please ask in comments if you have any question or you need any clarification.
If you like this post and you think it’s going to benefit someone you know, then please do share, tweet or email this post to them.
If you would like to receive new blog posts in your email, then you can subscribe with your name and email id on the sidebar.