- Stock Market Terms – The Top10 Market Terms You Need to Know (Part 1)
If you're investing in the stock market there are stock market terms you have to know in order to understand what the heck you're doing. With that in mind, here is a list of the top 10 stock market every investor should know. I hope everyone had a great 4th of July Independence Day holiday and came through it all relatively unscathed.Stock Market Term 10 -
Sell short – Selling short (also called “shorting” a stock) isn't a term that applies only to investors under 5' tall. Selling short refers to a strategy where the investor bets that a stock is going to fall, and if it does they'll realize a profit. Basically to sell a stock short an investor will borrow from their brokerage house in order to purchase a specific number of shares of a specific stock. They never actually own the shares, they're on loan to the investor.
At some point in the future, they have to repay those shares to the brokerage house. If they were correct, the shares will cost them less than they paid. For example, if they short 100 shares of XYZ corp at $10.00 a share, it costs them $1,000, except that they don't actually have to pay the $1,000 yet. They are obligated to repay the 100 shares of XYZ at some point in the the future, however. In this example if XYZ corp's stock drops to $7.00 a share, the investor can repay the brokerage house the 100 shares and realize a $3.00 per share profit.
One could have made tremendous profits shorting mortgage company stocks in the past year, but the shorting strategy does have a downside. One downside of short selling is that the upside is limited. You can only earn an amount per share that's equal to the share price. Obviously there isn't any more money in there. So, in this example, you could earn a maximum of $10 per share on XYZ. On the other hand in a traditional purchase your upside profit potential is pretty much unlimited. If XYZ went to $100 at some point in the future, you'd have made $90 a share.
Stock Market Term 9 -
Equity – An equity is analogous to a stock. It's an ownership stake in a company. When an investor purchases a share of stock they're purchasing a portion of ownership in the company. This is also called taking an equity position in the company. It's one of the two main ways a company raises money. Selling ownership in the company is called equity financing. The other way is selling bonds or notes, which are financial instruments that a company promises to repay with interest. Selling company bonds or notes is called debt financing.
Stock Market Term 8 -
Margin – Buying stocks on margin is borrowing money from your broker to buy shares of stock. This is strictly regulated by the Federal Reserve. It is a way an investor can use leverage to grow their investment, because they're using borrowed funds. This is just like when you purchase your house with 10% down, you're leveraging the 10% down payment to control a much larger asset. When the house appreciates you get the benefit of the entire appreciation, although you only paid 10%. As you can imagine, an investor can lose big time if the stock goes down, because you are leveraging both gains and losses.
The Fed requires investors to have a 50% equity in their accounts when buying on margin. So if you want to buy 100 shares the ubiquitous XYZ corp's stock at $10 per share you have to have at least $500 in your account to do so. In reality, because of Federal Reserve regulations, you can't get a margin loan from broker unless you have a minimum of $2,000 in your account.
Stock Market Term 7 -
Call Option – A call option is a contract that two investors enter into where one sells the other the right to purchase a certain security at a certain time for a certain price. The buyer is not obligated (hence the term “option”) to make the purchase, but the seller is obligated to make the sale for the agreed upon price, should the seller so choose. The buyer realizes their profit because they are buying an option to purchase a stock they are hoping they can sell on the open market for more than they paid. It's similar to (but not the same as) employee inventive stock options.
Say XYZ corp is trading at $10 a share and the buyer purchases options to XYZ for $12 a share. The seller locks in a $2.00 share profit because of the $2.00 premium. The buyer pays the $2.00 per share premium as a nonrefundable deposit. Should the stock rise above the $12.00 share price, the option buyer can then buy the stock for the $12.00 agreed upon price, and sell them for whatever the market value is on the day they sell them. The difference between the option price and the sales price is the investor's profit.
Stock Market Term 6
Put Option – A put option is basically the flip side of a call option. It gives an investor the option to sell a specific stock or commodity at an agreed upon price (known as the the “strike price”) at some point in the future. When an investor purchases a put option they are hoping the asset is going to lose value before they exercise the option.
For example, if they buy a put option for, you guessed it, XYZ corp, at $20 a share and XYZ drops to $15 a snare, they'll realize a $5 per share profit, minus the amount they paid for the option. If they paid $2 per share for the option their net profit would be $3 per share. It works like this:
The owner of the put contract buys XYZ at the market price of $15 a share then sells it as per the terms of the put option for $20 per share. They earn $5 per share, but had to pay $2 per share for the option, so they net $3 per share.
Stay tuned for Part 2 of the Top 10 Stock Market Terms - I'll post them tomorrow.
Don't forget to check out my post where I give you a review of the leading online discount stock brokers. If you want to save money in this, ah turbulent investing environment, you'll want to check out the post here:
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