Trading glossary is something every trader will need to understand. SimpleFX will take you through some of the main terms used in trading and explain what they mean.
What is arbitrage in trading? It happens when you can take advantage of price difference - buy an asset at one place and immediately sell it in another market with profit.
What does ask price refer to in trading? It’s the price a seller asks from buyers in a market. When the asking price matches the bid price (offered by potential purchasers) usually a transaction happens.
What is an asset in trading? It’s a resource that can be possessed and exchanged between parties. A bond, currency, equity, commodity, or cryptocurrency - are some examples of assets. In practice traders exchange assets themselves (spot market) or contracts tied to assets (ie. futures market).
Traders can teach computer programs to make trade orders for them. The practice is called algorithmic trading. The orders can be executed by simple rules, ie. decision tree, or by deep learning algorithms that are able to teach themselves.
What is a base rate. Central banks, such as Fed, Bank of England or European Central bank, set the rate they charge commercial banks for loans. Higher base interest rates slows inflation, rises income from bank deposits, but also rise the cost of borrowing, and negatively influences the stock market.
Bear and bull market
Bull and bear are symbols of uptrend and downtrend. Bears are skeptical, they expect the prices of an asset (cryptocurrency or stock) to go down, or even collapse. They usually try to short the companies or cryptos at the right time. On the other hand, bulls are optimistic about the future price. They want to buy low and sell in future.
What does it mean that one currency is pegged to another? Usually currencies used in different countries can be freely exchanged between buyer and sellers. It is less common that they are pegged, tied to the price of another currency, usually at the 1:1 ratio. Cryptos can be pegged aswell. The most popular are stablecoins tied to US dollar, such as Tether, USD Coin, or Binance Coin. Pegging a currency is tricky, as the central bank (or stablecoin issuer) needs to control the price.
Customer Price Index (CPI)
What is CPI? It’s one of the most popular tool to measure the inflation. It tracks the change of the prices customers pay for goods and services. It’s given in percentages. If it is too high central banks need to act and raise interest rates. The move can slo the economy down, but will help to curb inflation.
What is fundamental analysis? It’s one of the most popular approach to assessing the value of an asset. For companies it takes into account their cashflow, reserves, financial and market results, as well as future potential. Traders who can correctly measure the fundamentals of an asset can see market opportunities as the current market price may be lower or higher than the intrinsic value of a stock, commodity, or cryptocurrency.
You might have heard of futures. These are derivatives. Buyers and sellers agree to a transaction at a specific price at a specific time in the future. Futures are a good way to hedge current positions. They are also often more volatile than the spot market, as futures prices sometimes can drop to negative.
Gross Domestic Product (GDP)
What is GDP? Gross domestic product is the sum of the value of the goods and services produced in a country (or region). Usually economists measure annual GDP to check if the economy is growing or shrinking, and to compare the economic power of a territory.
Some trades, positions or investmets are done to make profit, other to reduce ones exposure to risk. Companies, countries, and individuals can hedge making a move opposite to their main position. You may hedge by shorting futures of an asset you own (Bitcoin, Tesla stocks), or by investing in an asset which price usually moves inversely.
High Frequency Trading (HFT)
What is HFT? The use of computers introduced algorithmic trading and high frequency trading. Automatic algorithms can perform trades faster than humans, and find a better price, buy and sell faster than a trader acting manually. HFT strategies can lead to “flash crashes”, when algorithms make the same mistake at the same time.
Initial Public Offering (IPO)
What does IPO mean? The shortest definition is the stock exchange debut - the first sale of the equity in the public market. IPO turns a private owned company into a public company as anyone can buy a stake in it. Companies raise new investment capital through IPO, the owners decide to sell part of their firm. Before an IPO investment banks and owners asses the value of the company and propose a price per share. However, on the day a company goes public big price movements are very common.
If you borrow money, you are supposed to pay interest to the lender. The price of the credit is usually expressed by annual percentage rate (APR). A second meaning of interest is the stake a stockholder has in a company, also expressed as a percentage.
What is intrinsic value? In finance the term is used to describe the true value of an asset, which usually is different from the market price. Companies, commodities, or currencies are undervalued or overvalued as it is difficult to assess the intrinsic value. Traders try to do it using fundamental analysis.
What is a limit order? Traders can open orders at a more attractive price than the current one. If you want to buy an asset, you can place a limit order at a lower price. If you are selling at a higher price. The limit order will be fulfille only when the market reaches your desired level.
What is leverage in finance? It’s a method of making more profit without investing more money. Traders can open a position using margin, which can be just a fraction of the value of an order. The margin trading provider lends the missing funds to their clients. Leverage allows you to make much more money if you are on the right side of the market, but if the market goes against you, you can quickly loose the margin.
When trading different assets you will quickly realize, that in some markets transactions happen very often, an don the others you’d need to wait several minutes for a price to change. This is the concept of liquidity. Liquid assets can be bought and sold any time, while less liquid assets (ie. expensive yachts) need a specific buyer.
When the funds on a trading account fall below the level needet to keep a position open, the owner receives a margin call warning. Unless more money is added to an account, the position will be automatically closed. In the past brokers would literally call their clients to inform about the situation, that’s where the term derives from.
When placing a stop order you want to execute a trade when the price is less attractive for you than the current one. Why would you want to do it? To stop loss. If you are holding an asset, you may want to sell if the price goes down before it crashes for good.