Trading Terms and Concepts

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Trading Indicators

Simple Moving Average (SMA)
- The SMA smooths the price of a security by calculating the average over a fixed time period. This can help identify trends in an otherwise noisy signal.

  • A common technique for using this indicator is looking for price breakouts: breakouts are crossovers of the price with the moving average. Bullish breakouts are indicated every time the price crosses above the average. Bearish breakouts are when the price falls below the average.
  • Note that because this moving average gives equal weight to all prices in the desired time range, recent market volatility may appear to be “smoothed out”. Long term averages such as the 200 day SMA, tend to eliminate the short term price volatility, while short term averages tend to neglect the long term trends.
  • Popular trading styles and patterns:
    • Days: 10, 50, 100, 200
    • 50 Day SMA is a popular support/resistance metric
    • Death Cross - sell signal
    • Golden Cross - buy signal

Exponential Moving Average (EMA) - The EMA is very similar to the SMA except it places greater weight on more recent prices, which allows the moving average to be more sensitive to recent volatility.

  • This form of a moving average is often used in 10, 12, 26, 50, and 200 day periods.
  • A common technique for using this indicator is looking for price breakouts: breakouts are crossovers of the price with the moving average. Bullish breakouts are indicated every time the price crosses above the average. Bearish breakouts are when the price falls below the average.
  • An EMA does serve to alleviate the negative impact of lags to a certain extent. Because the calculation places more weight on the most recent price, the average reacts more quickly to recent market changes. This can be beneficial when an EMA is used as a trading entry signal

Moving Average Convergence/Divergence (MACD) - MACD is an oscillator widely used for trending and the momentum following of a stock. This is calculated as the difference between two price averages, typically subtracting the 26-day EMA from the 12-day EMA. A 9-day EMA of the MACD is normally used as the "signal line" and is plotted on top of the MACD line, which can function as a trigger for buy and sell signals.

  • Traders may sometimes buy the security when the MACD crosses above its signal line and sell the security when the MACD crosses below the signal line.

Relative Strength Index (RSI) - This is a technical indicator that rates the strength of stock on a scale of 0-100. It is intended to evaluate the “relative” strength or weakness based on recent changes of price range. It is widely used as an overbought/oversold indicator, typically with values of 30 or below for oversold and 70 or above for overbought.

  • The “default” levels of RSI at 30 and 70 can be adjusted to better fit the recent price movement. It is important to keep in mind that during periods of very strong trends, a security’s price may continue to rise for a long time after an oscillator such as the RSI signals “overbought” conditions. The inverse applies to extended downtrend price movement that may occur well after an RSI indication of “oversold”.

Average True Range (ATR) - ATR is a volatility indicator showing the range an asset moves, on average, during a given time frame. The true range is calculated by taking the highest absolute value of the following:

  • This value is taken for each period and then the average is calculated over a specified number of days, most commonly a 14-day average
    • Current high minus the previous close
    • Current low minus the previous close
    • Current high minus the current low
  • This value is taken for each period and then the average is calculated over a specified number of days, most commonly a 14-day average.
  • This indicator can be useful for entering or exiting positions; however it is not typically a good idea to make decisions based on ATR alone. It is most commonly used in conjunction with a strategy in order to help “filter” your buy and sell signals.
  • Suppose you are using PSAR strategies to trade a particular stock. When combined with the ATR, you are able to set definitive price points that will help you take full advantage of a trending market while helping minimize your risk. Assume a stock averages a $1 move per day. If the stock is already up $1.20 on the day (assuming no major news) and the trading range (high minus low) is $1.35, then the price has already moved 35% more than the average. A buy signal here could very well be accurate, but since the price has already moved significantly more than average, betting that the price will continue to go up and expand the range even further may go against the odds being calculated by your ATR.

Parabolic Stop and Reverse (PSAR or Parabolic SAR) - This is a technical indicator used for analyzing trends. When the price is trending up, the SAR will appear below the price and converge up towards it. In a downtrend, the SAR appears above the price and converges downwards. The PSAR indicator uses the most recent extreme price (EP) along with an acceleration factor (AF) to determine where the indicator dots will appear. PSAR is calculated as follows:

  • Uptrend: PSAR = Prior PSAR + Prior AF (Prior EP - Prior PSAR)
  • Downtrend: PSAR = Prior PSAR - Prior AF (Prior PSAR - Prior EP)
    • Where:
      • EP = Highest high for an uptrend and lowest low for a downtrend, updated each time a new EP is reached.
      • AF = Default of 0.02, increasing by 0.02 each time a new EP is reached, with a maximum of 0.20.
  • The PSAR Crossover is a popular predictive indicator that occurs when the PSAR crosses the price on a chart. Generally, it is considered a bullish or a buy signal when PSAR falls below the price and bearish or a sell signal when PSAR goes above the price.
  • PSAR can be used in tandem with other indicators to help filter out strong and weak trading signals. Popular indicators used in conjunction with PSAR include stochastics, moving averages, and ATR.

Financial Terminology

10-K - the 10-K is a comprehensive report filed annually by a publicly traded company about its financial performance and is required by the SEC. This type of report contains much more detail than a company's standard annual report.

10-Q - The SEC form 10-Q is a comprehensive report of a company's performance that must be submitted quarterly by all public companies to the Securities and Exchange Commission (SEC).

Acquisition - An acquisition is when one company purchases most or all another company's shares to gain control of that company. Purchasing over 50% of the available shares and assets allows the acquirer to make decisions about the newly purchased assets without the need of approval from the other shareholders of that company.

After-Hours - After-Hours trading starts at 4:00 pm EST after the market closes. This session can run until as late as 8:00 pm, however volume typically thins out much earlier in this session.

Altman Z-Score - This was created in the 1960s by Edward Altman, this score indicates the probability of a company entering bankruptcy within the next two years. It uses profitability, leverage, liquidity, solvency, and activity to predict the likelihood of a company becoming bankrupt.

American Depositary Receipt (ADR) - An ADR enables US investors to access ownership of foreign public companies. They are beneficial for foreign companies since it enhances investor interest in their shares beyond their country's market.

Annual Report - An annual report is a document that public companies must provide to its shareholders annually, it describes their operations and financial conditions.

Alpha - Alpha is the measurement of the performance of an investment in relation to a benchmark index. It is often referred to as a percentage, so an alpha of 1% means that the return on investment was 1% better than the benchmark.

Arbitrage - This is a technique used to take advantage of differences in price in substantially identical assets across different markets or instruments.

Assets - An asset is a resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide a future benefit. Assets are reported on a company's balance sheet and are bought or created to increase a firm's value.

Backwardation - If the current cash price for an asset slip above the price for forward delivery.

Balance of Payments - This refers to the accounts that sum up a country's financial position relative to other countries.

Balance Sheet - A balance sheet is a financial statement that reports a company's assets, liabilities and shareholders' equity at a specific point in time. It provides a snapshot of what a company owns and owes as well as the amount invested by shareholders.

Bearish - A bearish investor is someone who believes the market is headed downwards and will attempt to profit from the decline of stock prices. Bears are pessimistic about the state of a given market; therefore they 'borrow' shares from their broker who then sell it at the current market price. If the stock falls in price, the bear will return the shares to their broker and net a profit, this is called 'shorting'.

Beta - Beta is a way to measure the relative risk of a share.

Bid-Ask Spread - This is sometimes called the bid-offer spread, it is simply the difference between the price at which you can buy a share and the price that it can be sold at. If the bid is $2 and the ask is $2.20 then the spread is $0.20.

Bonds - A bond is a type of debt instrument issued and sold by a government or company to raise money. Investors who buy bonds are paid interest which for bonds are known as a 'coupon'.

Bonus Issue - This is most common among British companies; wherein free additional shares are added to the positions of existing shareholders.

Breakeven - This is the price that an asset must hit in order to enable an option buyer to recover their premium

Bullish - A bull is an investor that thinks the price of a stock is subject to rise due to either technical or fundamental analysis. Investors with a bullish approach purchase shares under the assumption that they can sell it later for a higher price. Bulls look to profit from the upward movement of a stock.

Call Options - These allow the holder to buy the asset at a stated price within the specific timeframe.

Candlesticks - A candlestick is a form of price chart used in technical analysis that displays the high, low, open, and closing price of a stock within a specific timeframe. It originally formed from Japanese rice merchants and traders to track market prices and daily momentum hundreds of years before being a norm in the U.S.

Capital Gain - Capital gain is an increase in a capital asset's value. It is considered to be realized when you sell the asset. A capital gain can occur on any security that is sold for a price higher than the ask price that was paid for it. Capital gains are realized once the asset is sold, unrealized gains and losses demonstrate an increase or decrease in an investment's value but have not yet triggered a taxable event (exiting the trade).

Cash flow - Cash flow is the net amount of cash and cash-equivalents being transferred into and out of a business. A company's ability to create value for shareholders is determined by its ability to generate positive cash flows.

Cash Flow Statement - A cash flow statement is a financial statement that provides aggregate data regarding all cash inflows a company receives from its ongoing operations and external sources of investments. It also provides cash outflows that pay for business activities and investments throughout a specific period.

Cognitive Bias - Humans use mental shortcuts (heuristics) to make a quick decision. These work in many circumstances, but when it comes to investing, they can be a major handicap due to irrationality.

Consolidation - From a technical analysis perspective, consolidation refers to the oscillation of an asset between a well-defined pattern of trading i.e., a consistent rate of up and down. Consolidation is interpreted as market indecisiveness, which ends when the asset price either breaks resistance or support.

Convexity - Convexity is a concept in finance where there are non-linearities in a potential output after adjusting an input variable. This term is typically used when describing trading patterns.

Correlation - This describes the mutual relationship between two independent values. In trading, it is used to find out whether there is a relationship between two variables and if there is, what kind of relationship there is. -1 represents a negative correlation, 0 implies no correlation and 1 suggests a positive correlation.

Day Trading - Day trading is a form of trading whereby an individual will execute trades either long and/or short on intraday (within the day) market price action. A day trader will typically not have any open positions after the market closes.

Defensive Stocks - Defensive stocks are based on underlying assets which tend to be less prone to economic cycles. Considering this, they're generally invested in when traders see an economic slowdown approaching and want to hedge their portfolios.

Deflation - Deflation occurs when the nominal prices of goods and services drop. Deflation is a positive from a consumer's perspective as it directly boosts the purchasing power. However, it can have a negative effect on the economy.

Delta - Delta is the ratio that compares the change in the price of an asset, usually marketable securities, to the corresponding change in the price of its derivative. For example, if a stock option has a delta value of 0.65, this means that if the underlying stock increases in price by $1 per share, the option on it will rise by $0.65 per share. This can be a very useful metric in momentum based strategies.

Derivatives - This is the collective term used for a wide variety of financial instruments whose prices derive from or depend on the performance of underlying assets, markets or investments.

Diversification - This is an investment strategy focused on risk mitigation, it calls for the creation of a portfolio that contains a variety of investments. The aim of this is to neutralize negative yields by the positive yields of other investments in the portfolio.

Elliot Wave Theory (EWT) - This theory makes use of fractal and repetitive patterns to predict future market movements. It was developed in the 1930s by Ralph Nelson Elliot who recognized the fact that investors' psychology gives rise to certain 'wave' patterns in stock price action.

Equity - An equity represents the amount of money that would be returned to a company's shareholders if all the assets were liquidated, and all the company's debt was paid off in the case of liquidation. In a case of acquisition, equity is the value of company sales minus any liabilities owed by the company not transferred with the sale. Equity can be found on a company's balance sheet and is the most common data analyzed to assess the financial health of a company.

Exchange-Traded Funds (ETF) - These are baskets of securities that act like securities themselves. They track an underlying index (comprising all the securities covered by the ETF) and they are marketable. There is no limit on what an ETF can contain, for example: stocks, bonds, and commodities.

Exit Strategy - An exit strategy is a contingency plan that is executed by investors, traders, business owners etc. to liquidate a position in a financial asset once predetermined criteria have been met or exceeded. For day traders, a stop loss/limit is a form of exit strategy since they are choosing when to exit the trade based on a certain criterion (price) being met.

Exponential Moving Average (EMA) - An EMA is a type of moving average that places a greater weight and significance on the most recent date points relevant to your time frame. EMA's react more significantly to recent price changes than a simple moving average. It is used to create buy and sell signals based on the crossover and divergences from the historical average.

Financial Instruments - Financial instruments are assets that can be traded, or they can also be packages of capital that may be traded. Most types of financial instruments provide efficient flow and transfer of capital all throughout the world's investors. These assets can be cash, a contractual right to deliver or receive cash.

Float - Float refers to the regular shares a company has issued to the public that are available for investors to trade. A company's float is an important number for investors since it indicates how many shares can be bought and sold by retail investors (us!). Float does not include restricted shares, these are shares that are on a sale restriction, meaning that they may be owned by insiders of the company. The less shares in the market, the higher the volatility!

Fundamental investing - Researching a company and their revenue reports, data, headlines etc. and using this information to make an educated decision on a trade.

Futures - Futures are derivative financial contracts that obligate the parties to transact an asset at a predetermined future date and price. The buyer must purchase, or the seller must sell the underlying asset at the set price, regardless of the current market price at the expiration date.

Gap Scanning - Gaps are areas on a chart where the price of a stock moves sharply up or down with little to no trading in between. As a result, the asset's chart shows a gap in the normal price pattern, these gaps can then be exploited for profit by traders.

Hedge - A hedge is an investment that is made with the intention of reducing the risk of adverse price movements in an asset. Typically, a hedge consists of taking an offsetting or opposite position in a related security. While hedging reduces the potential risk of losing money, it also chips away at potential gains.

Income Statement - An income statement AKA 'profit and loss statement (P&L)' is an important financial statement used to report a company's financial performance over a specific accounting period e.g., first quarter (Q1).

Index/Indices - Market indices are a hypothetical basket of securities which provide a relevant snapshot of a given market. The value of an index reflects the values of its included securities.

Individual Savings Account (ISA) - Individual savings accounts are a way of saving and investing without paying income tax or capital gains.

Inflation - Generally, inflation is the rate at which the value of a currency decreases and, therefore, the purchasing power of the dollar decreases. The Consumer Price Index (CPI) is the most common measure of inflation at any given point in time.

Information Ratio - Sometimes referred to as the appraisal ratio, works to measure the risk adjusted return of a financial asset portfolio (a collection of assets).

Interest Rates - An interest rate represents the amount of interest that is due per period in relation to the amount borrowed. Interest rates can refer to any period, but it generally takes the form of an annual percentage.

Leverage - Leverage occurs when using borrowed capital as a funding source when investing to expand the firm's asset base and generate returns on a risk capital. This strategy involves using borrowed money to increase the potential return of an investment. Leverage can be referred to as the amount of debt a firm uses to finance assets.

Liabilities - A liability is something a person or company owes, usually an amount of money. Liabilities are settled over time via the transfer of economic benefits such as money, goods, or services, Liabilities include loans, mortgages, and accrued expenses.

Liquidity - Liquidity is the term used to dictate the ease of which an asset or security can be converted into ready cash without affecting its market price. Liquidity describes the degree to which an asset can be quickly bought or sold in the market without it affecting its intrinsic value. Cash is considered the most liquid asset because it can most quickly be converted into other assets.

Momentum Trading - Momentum trading is a strategy that looks to capitalize on a stock's momentum to enter a trend as it is picking up movement in a certain direction. Momentum refers to the price trend continuing either to rise or fall whilst considering the price and volume information.

Moving Average (MA) - Generally speaking, the moving average helps to identify average price data, by calculating the moving average, the impacts of random, short-term fluctuations on the price of a stock are mitigated as you have an understanding of the movement of a stock price. The most common moving averages are Simple Moving Average (SMA) and Exponential Moving Average (EMA).

Moving Average Convergence/Divergence (MACD) - MACD is an oscillator widely used for trending and the momentum following of a stock. This is calculated as the difference between two price averages, typically subtracting the 26-day EMA from the 12-day EMA. A 9-day EMA of the MACD is normally used as the "signal line" and is plotted on top of the MACD line, which can function as a trigger for buy and sell signals.

Options - Options are financial instruments that are derivatives based on the value of underlying securities such as stocks. An option contract offers buyers the opportunity to buy or sell the underlying asset. Unlike futures, the holder is not required to buy or sell the asset if they choose not to do so.

Paper Trading - Paper trading is a simulated trade that allows new investors to practice their strategies without the risk of losing money. The term refers to when aspiring traders would practice on paper before making real trades with real money. Paper trading allows you to see whether or not your strategy is working.

Pattern Day Trader (PDT) - The PDT rule is a regulation for traders using Financial Industry Regulatory Authority (FINRA) regulated brokers that execute four or more day trades over the span of five business days using a margin account. Pattern day traders are required to hold $25,000 in their margin accounts to bypass the PDT rule. Breaking this rule will result in a 90-day ban from your platform.

Pre-Market - The pre-market is the period of trading activity that occurs before the regular market session opens. The pre-market occurs between 8:00am and 9:30am EST each trading day. Many day traders watch the pre-market activity to judge the strength and direction of the market in anticipation for the regular trading session.

Pre-Market Scanning - Pre-market scanning allows you to identify potential stocks of interest with the help of a screener, a good analogy of this is relating it to the way avid horse race better choose their horse, they will analyze the horse’s performance prior to the race (market open) and make a decision. Of course, you cannot predict which horse (stock) will make you money, but you can get a good sense of which one to back.

Premium - Premium can mean several things in finance, the first being the total cost to buy an option. A premium is also the difference between the price paid for a fixed-income security and the security's face amount at issue.

Price Earnings Ratio (P/E Ratio) - This is the ratio of a company's share price relative to its earnings per share. A common fundamentals and value investing metric.

Put Options - These allow the holder to sell the asset at a stated price within the specific timeframe.

Rebalancing - This is the process of buying or selling a portfolio of assets in order to keep the original asset allocation that was specified. Example: You want 5% of your portfolio to be exposed to Apple stock but after a few months Apple has appreciated so much that it now accounts for 8% of your total portfolio! In order to keep in line with your original allocation, you would sell enough Apple stock to lower your exposure by 3% to get back to your 5% allocation (8% - 3% = 5%).

Resistance Line - The resistance line is the price at which an asset meets pressure from sellers at a general price zone. New information can change the market's attitude towards the price of an asset and can result in the price breaking the resistance line. The resistance line can be charted by drawing a line along the highest highs for a specific time period.

Risk Reversal - Risk reversal is an options strategy designed to hedge directional strategies. For example, a long position will be hedged two-fold in a risk reversal scenario.

Relative Strength Index (RSI) - This is a momentum indicator used in technical analysis that measures the magnitude of recent price changes to evaluate overbought or oversold conditions in the price of a stock. Typically, a 30 or below indicates the stock may be oversold (undervalued) and a reading of 70 or higher indicates the stock may be overbought (overvalued).

Scalping - Scalping is a trading strategy geared towards profiting from minor price changes in a stock's price. Traders that follow this strategy tend to make much more trades in a day when compared to a trader that trades gappers for example as they believe small movements in stock price are easier to catch than large ones.

Security - Securities are negotiable financial instruments that hold some form of monetary value i.e., stocks.

Shareholder - A shareholder or 'stockholder' is a person or company that owns at least one share of a company's stock, which is known as equity. Due to shareholders essentially owning a segment of a company, they reap the benefits of a business' success.

Sharpe Ratio - The Sharpe ratio is a way to determine how much return is achieved per each unit of risk. It is useful to, and can be computed by, all forms of capital market participants to evaluate their performance from day traders to long-term buy-and-hold investors.

Stock - A stock (also referred to as equity) is a security that represents ownership of a fraction of a corporation. The owner of the stock is entitled to a proportion of the corporation's assets in relation to how much stock they own. Units of stock are called 'shares'.

Simple Moving Average (SMA) - The SMA uses the prices of a security over a given time period (typically a number of days) to calculate an average. It is essentially the average of a stock price over time.

Stock Screener - A stock screener is a set of tools that enable investors to quickly gather information about a range of stocks that relate to the investors search criteria. Some brokers offer stock screeners on their platform, however there are independent stock screeners available. Stock screeners can convey the volume of a stock, price changes, float and much more.

Supernova Pattern - The supernova is an explosion in stock price that creates many opportunities to buy on the way up and short on the way down. Supernovas can be triggered through world events, social media hype and company news. Stocks that experience supernovas hold massive volatility and liquidity and therefore are risky if investors join the hype too late (GME as a prime example).

Support line - The support line refers to the price level that an asset does not fall below within a specific timeframe. The support level is created by buyers entering the market whenever the asset dips to a lower price. Using technical analysis, the support line can be identified by drawing a line underneath the lowest lows for the specific timeframe. The support line can be horizontal, slanted, or up and down following the price trend.

Swing Trading - Swing trading is a style of trading that attempts to capture short-term to medium-term gains in a financial instrument over a period of a few days to several weeks. Swing traders are more likely to use both fundamental and technical analysis to influence an execution of a trade.

Technical Analysis - Technical analysis focuses on understanding trends, price movement, and volume. Technical analysis is often used to generate short-term trading signals using charting tools, scanners and indicators.

Time frame - A time frame refers to the type of time per open and close of a stock that traders use to determine trends in the market. Day traders typically use smaller time frames such as 1-min and 5-min as it is relevant to their trading style. However, it is important to also refer to longer time frames such as 1-hour and 1-day to get a better indication of the stocks overall trend.

Treynor Ratio - The Treynor ratio, also known as the reward-to-volatility ratio, is a measure that quantifies return per unit of risk. It is similar to the Sharpe ratio.

Underlying Security - An underlying security is a stock or bond on which derivative instruments, such as futures, ETFs and options are based. It is the primary component of how the derivative gets its value.

Volume - Volume is the amount of an asset or security that changes hands between buyers and sellers over a period of time.

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