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Concepts and terms all investors should know

Davis MartinDavis Martin ·

There’s a lot of lingo to learn when you first start trading or investing.

Financial literacy is key to good saving and spending, and savvy trading and investing. Couple financial literacy with discipline and proper preparation and you have the underpinnings of success.

Here are some concepts that will get you up the learning curve and help you get started in the markets.

Inflation or deflation?

Economics plays a key role in investing; economic conditions can move the market in either direction.

One of the main things to focus on these days is inflation. Inflation is simply the rising price of goods and services; deflation, by comparison, is the exact opposite, occurring when the prices of goods and services are falling (think back to the financial crisis when prices were falling). Inflation — and deflation too — is measured by the Consumer Price Index (CPI), a government measure of price movements in common items purchased/used by most people.

If you’re a value investor, you might find that deflationary environments provide better opportunities, as stocks may be depressed, and you can buy more with less. However, in times of deflation, business tends to slow, which can affect the growth of companies, which in turn can affect consumer spending as individuals fear layoffs and tighten up.

Generally, stocks perform the best when there is a low level of inflation — which is what has been in place for years now — as companies are able to generate profits due to a healthy economy, as well as consumers purchasing more.

‘Dovish’ or ‘hawkish’?

The Federal Open Market Committee (FOMC) plays a large role in the markets. The Federal Reserve, or Fed, decides the level of interest rates, which impacts some stocks and commodities. When traders or investors refer to the FOMC meeting announcement as dovish, it means that the Fed is looking to leave interest rates low, or unchanged. On the other hand, a hawkish Fed is looking to raise interest rates.

When the Fed is more hawkish, you would expect to see U.S. Treasury securities and gold prices fall, while volatility picks up in the equity market. The opposite is true when the Fed takes a dovish view.

Short selling

Short sales allow you to bet against a stock, profiting if the price falls. Essentially, it works by selling shares you don’t own.

To sell something short, you borrow shares from your broker and sell them on the open market (you need a margin account to do this). When you close out a short position, you buy back the same number of shares you borrowed.

By returning those shares to the broker, you are “covering” your trade. If the stock has indeed declined in price, you bought them back at less than you got when you sold them in the first place, and you pocket the difference (minus margin costs).

Final thoughts

There are a lot of terms to learn when you are starting out. If you hear terms and phrases and aren’t completely sure what something means, take the time to learn it rather than you assume you know it because you hear it tossed around in the news or on your favorite trading site. The more you understand the underlying terms and concepts, the easier it will be to pick up the nuances of trading.

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  Davis Martin is the lead publisher at DailyProfitMachine.com. He trades SPY calls and puts and swing trades mid-large cap stocks and stock options.

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