The very first thing any investor should do before venturing into the stock market is understand the basic stock market terms. These terms enable investors to analyze market trends, make informed decisions, and avoid common pitfalls. Some of the basic stock market terms include bull market, bear market, IPO, blue-chip stocks, market capitalization, and P/E ratio. Whether you are a new or seasoned investor, it is important to learn the terms to understand the intricacies of stock trading and long-term investing.
Basic Stock Market Terms
To invest successfully, you need to understand the language of the stock market. Below are 20 essential stock market terms, explained with simple definitions and examples.
Stock
A stock shows ownership in a company. If you buy into a firm’s stock, you own or share a tiny portion of that business. This means you have a share in the prosperity of the company. If the company prospers, then your stocks increase automatically in value. At this juncture, you can sell your stock at a higher price for a gain.
Companies issue stocks to raise the operation of such firms. Stocks can benefit investors from the earnings of the firms. Some companies pay their investors dividends, providing them with extra sources of income. It offers people an opportunity to build wealth over time.
Share
The smallest unit of ownership in a company is a share. A company issues shares to the public whenever it requires funds. An investor can purchase the shares and, in return, become a partial company owner. More shares translate to a higher percentage of ownership in the company.
Shares encourage companies to grow through investment. Investors can sell these shares in the stock market. The share price fluctuates with supply and demand. The more people want a share, the higher it becomes. If the demand decreases, the price goes down.
Stock Exchange
A stock exchange is a market that deals with stocks. In India, the major stock exchanges are the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). The two exchanges help the investors find a platform for safe and efficient stock trade.
Stock exchanges allow companies to raise money by selling shares. They also provide liquidity, allowing investors to sell their stocks at any time. The rules the exchanges follow ensure fair trading and protect investors from fraud.
IPO (Initial Public Offering)
An IPO is the initial offer to the public in exchange for shares. Generally, a company floats its first public offering of shares to raise funds for its business expansion. An investor can invest in a company in its early growth stages.
Once a company completes its IPO, its shares begin trading on the stock exchange. Many investors are attracted to IPOs, but there are risks associated with them. A company’s stock price may increase or decrease according to demand and business performance.
Market Capitalization
Market capitalization, which in short is known as market cap, is the total value a company holds in its stocks in the market. It is basically calculated as the product of multiplying the price per share by the total number of outstanding shares. Generally, a high market cap indicates large companies, and a low market cap represents smaller companies.
Market cap is a term that helps investors understand the size and stability of a company. Large-cap companies are usually stable, while small-cap companies have a higher growth potential but more risk. Investors use market cap to compare different companies.
Bull Market
A bull market is when stock prices rise continuously. Investors increase investment as they become confident. Economic growth, low interest rates, and good company profits are reasons for a bull market.
In a bull market, investors earn more. Many new investors come into the stock market to capitalize on rising prices. However, prices may drop suddenly if investor confidence weakens.
Bear Market
A bear market is when the stock prices drop by 20% or more over time. This usually occurs during economic downturns, recessions, or financial crises. Investors lose confidence and sell their stocks, which further declines.
Bear markets scare investors. Nevertheless, seasoned investors buy quality stocks at cheap prices during this time. Such investments usually yield good returns when the market picks up again.
Dividend
A dividend is a share of the profits made by a company that is given to its shareholders. Companies share their earnings with investors as dividends. Some companies pay dividends quarterly, while others pay them annually.
Dividends offer a regular flow of income to investors. Dividend-paying companies are generally financially sound. Dividend-paying stocks are preferred by stability-seeking investors.
P/E Ratio (Price-to-Earnings Ratio)
The P/E ratio is a tool that measures stock price in the context of what the company will earn per share. Any high P/E ratio means your stock is dear, while it is undervalued if low.
Using the P/E ratio allows investors to compare different stocks. Lower values are a better investment chance. However, since many other factors also affect a stock’s value, investors would compute further metrics before deciding.
Blue-Chip Stocks
These are large-capitalization, financially stable companies with a good history of consistent earnings and growth. Among them are Reliance, HDFC Bank, Infosys, and Tata Steel.
Blue-chip stocks are safe investments. They offer stable returns and fixed dividends. Most investors prefer blue-chip stocks for long-term wealth building.
Intraday Trading
Intraday trading involves buying and selling stocks on the same day. Traders look to generate small profits based on minute fluctuations in prices. Such trading calls for market savvy and fast judgment.
Intraday trading is risky since changes in stock prices are very fast. Successful traders practice using a stop-loss order to minimize loss. One should train with a virtual platform before fully engaging in intraday trading.
Portfolio
A portfolio is an investment account that includes stocks, bonds, and mutual funds. A balanced portfolio reduces risk and maximizes returns.
Diversification is the way to a good portfolio. Diversification helps protect against losses by investing in different types of assets. Long-term investors create portfolios based on their financial goals and risk tolerance.
Bid Price & Ask Price
The bid price is the most a buyer offers to pay for a particular stock. The ask price is the lowest price a seller is willing to accept. The difference between them is called the bid-ask spread.
A small bid-ask spread suggests high liquidity for trading stocks, while a high spread indicates a low demand or high volatility for the stock. Investors check for the spread before placing orders.
Stop-Loss Order
A stop-loss order sells a stock automatically when it hits a certain price. This can prevent further loss if the price of the stock drops suddenly.
Stop-loss orders help investors manage risk. Traders use them to protect profits and avoid large losses. The right stop-loss level is very important for effective trading.
Short Selling
Short selling is when a trader sells borrowed shares expecting a price drop. Later, they buy back the shares at a lower price and return them, keeping the profit.
Short selling enables traders to benefit from falling stock prices. But if the prices rise, the trader will suffer heavy losses. Short selling requires experience and careful risk management.
Limit Order vs Market Order
A limit order allows investors to buy or sell stocks at a specific price. A market order executes the trade immediately at the current price.
Limit orders will give better control over trade prices but may not always execute. Market orders will ensure quick execution but may not get the best price. Based on the trading strategy, investors choose which order type they will use.
Circuit Breaker
A circuit breaker temporarily shuts off trading when the stock price moves too fast. It prevents panic buying or selling. Percentage drops are how exchanges set circuit breaker limits.
Circuit breakers prevent investors from suffering enormous losses. The trading resumes after the market stabilizes. It is through this system that fair trading conditions are upheld.
Leverage & Margin Trading
Leverage helps traders borrow money to increase the size of their investments. Margin trading allows investors to purchase more stocks than they can pay with a small deposit.
Leverage increases profit potential but risk escalates. Traders have to handle risk properly lest they incur huge losses. Margin trading should be approached by experienced traders only.
Beta (β) – Stock Volatility
Beta (β) measures a stock’s movement compared to the market. If the beta is 1, the stock moves with the market. A beta of more than 1 indicates more volatility, while a beta of less than 1 means lesser volatility.
Investors use beta to measure risk. Low-beta stocks are stable, while high-beta stocks offer more rewards but with more risk. Beta helps investors choose stocks according to their risk tolerance.
ETF (Exchange-Traded Fund)
An ETF is a basket of shares that trades just like a share. ETFs offer diversification and risk aversion.
Investors invest in lots of stocks using ETFs, without choosing specific companies. The easiest and cheapest way to access the stock market would be using ETFs.
Basic Stock Market Terms FAQs
1. Which of the following are the most critical stock market basics?
Stock, IPO, bull market, bear market, P/E ratio, and market capitalization.
2. What is the definition for an IPO within the stock market?
An IPO refers to the Initial Public Offering that issues the company’s shares to the public for the first time in their history.
3. What is the difference between a bull market and a bear market?
A bull market is up stock price and a bear market is down stock price.
4. How does market capitalization affect your stock investment?
Market capitalization determines whether the stocks are large-cap, mid-cap, and small-cap. Large-cap, mid-cap, and small-cap really affect the risk and return potential .
5. What is a blue chip stock?
A blue-chip is a financially stable company, with a history of stable earnings and consistent dividends.
