So you wanna play at the big table with the big boys and make some cash?
You’re ready. You have a little money saved and you’ve been watching CNBC and are ready to build an empire from your laptop.
Before you begin, there’s a little bit of learning to be done.
I’ve been trading online for years and in this post I’m going to teach you the first seven terms you need to know before you put your hard-earned cash on the line.
Read and learn before you play, it might save you a few headaches and a lot of money!
Beginners Trading terminology explained
When you take a position in the stock market you are either going short or going long.
Simply put, short means you are selling because you believe the price of a stock will fall and long means you are buying in the hope the price will rise.
It’s also worth noting that it’s entirely possible to sell stocks you don’t even own. This is what short selling means. You sell a stock at let’s say $10.00 a share and close the trade at say $6.00 a share, pocketing the $4 difference per share.
This can be very useful because it’s quite a bit easier to guess when a stock is going to fall – any bad news, scandal or information causing investors to feel fear or uncertainty will usually cause a stock price to tumble, giving you a valuable opportunity to cash in.
Remember: Long is up, Short is down. It’s that simple.
2) Forex Trading
Forex is the mac daddy of all markets, the foreign exchange market. This is the biggest market of all, which operates 24-7-365 without regulation or any real rules.
You buy and sell currency, and you are able to borrow up to 100x what you have put in as a deposit. This is known as trading on margin, but more on that later. So, for a deposit of $10,000 you’ll be able to control a block of $1,000,000 in currency. Just make sure you have the capital to absorb any losses as those margin calls will come and you can lose your shirt if it goes the wrong way!
Forex trades to the 6th decimal place and anything after the decimal point is known by traders as a pip.
Currencies are also traded in pairs and you’ll have to take a position deciding which will gain or lose on the other. For example if you place a trade long on the USD against the Japanese Yen, you’ll gain money for every fraction of a cent the USD gains on the yen.
Again, there are times of the year when things are actually predictable. If a central bank comes out and announces more quantitive Easing (printing money to pump into the economy) it’s a good bet that currency will fall in value against other stronger currencies like the British Pound or Swiss Franc or the USD.
If you think Forex may be your interest, I recommend reading up on www.babypips.com for more free education.
3) Margin/Margin Call
Trading on margin means borrowing money to trade when an opportunity arises and you don’t have as much cash as you would like to trade with.
As previously mentioned, in Forex trading for example, you can borrow 100x what you have in your trading account, meaning with $10,000 you can control a $1,000,000 block of currency for the trade.
A margin call will happen when the trade moves in the opposite direction you predicted and you’re initial funds (not including the borrowed cash) are exhausted. You will either have to provide more funds or the trade will be closed automatically.
Obviously, trading on margin is extremely risky and you need to be 99.9% sure the trade is going to go in the direction you believe. If it doesn’t, you could end up losing more money than you even deposited to begin with, leaving you in some serious hot water.
I personally knew someone who amassed a billion dollar fortune trading sugar futures on margin in the eighties. In one month he lost everything and then some, and worked for my dad in a crummy little office for the rest of his life selling furniture to pay off his debts, living in government subsidized housing.
The message here is clear: margin is a fickle mistress. She can bathe you in glorious riches beyond your dreams and just as quickly strip you of everything you ever had.
Treat her with respect or you will pay the price.
4) Stop Loss
A stop-loss os your friend. Always remember that.
A stop-loss is your ability to tell a computer to stop your trade automatically once it goes in the wrong direction by a certain amount of cents.
Let’s say for example you buy shares in Coca Cola since they’ve released a new soft drink that has taken the world by storm and you reckon this quarter will deliver tidy profits. Coke is trading at $40 on the day you place a long trade and you buy 100 shares. You also set a stop-loss at $39.30.
What this means is that if Coke announces under expected earnings and the share price drops, once it falls to $30.30 your trade will automatically close and the most you stand to lose is 70 cents a share, or $70.
That’s probably a fair risk in most people’s books.
The stop-loss is your friend. Repeat that. Write it down somewhere you can see it. Etch it into your brain and remember it always.
This one is relatively simple. A bull market is a market which is climbing or going up, a bear market is one which is falling or going down.
After the 2007 financial meltdown we saw a long, painful bear market. More recently during the so-called recovery, we have seen a bull market swelling the DJIA to record heights.
Investors have a saying which I have mentioned before but is worth repeating here “The bull goes up the stairs and the bear comes out the window”.
Markets rise slowly and fall fast. If you’re going to be in the game, you need to be ready for that.
This is extremely important and you need to factor this into every possible trade.
Liquidity just means the ability to switch your investment back into hard cash. It means you can easily sell it and offload it when you feel its time to take profits or the market or particular stock is going to change direction.
As I mentioned in my previous article on trading precious metals, that is an extremely liquid market and selling the precious metals you buy will usually be no problem.
An example of a market with poor liquidity would be some of the more exotic bond markets. For example, the government of Pakistan will pay you roughly 11% to lend it money at the time of writing (as opposed to 2% paid by the US government), but you try selling a Pakistani government bond in a market crash and you’ll see what it means to have a liquidity problem.
In short, you need to be sure somebody wants to actually buy what you’re going to sell when the time comes. That 11% is surely a high yield, but it comes at a price: greater risk and lower liquidity.
By the time you find a buyer for your bond in a crash, it may be too late.
When you purchase stock in a company you are becoming part owner of that company for however long you decide to hold the stock certificate for.
As part owner, you will get to share in the profits of that company. This is what’s called a dividend.
Of course, companies don’t just take their profits and split 100% of it between investors, they generally have to set aside a sum for future growth and expansion plans. They take a percentage of the profits and split them up while the rest goes back into the company which in time should increase the value of your shares.
Dividends vary widely. A big oil company, for example Exxon Mobil, will pay very low dividends in the range of 1-2 %, whereas a finance company focused on rapid expansion may pay anywhere up to 20-30%.
As always, risk and reward go hand in hand. It’s a pretty safe bet that Exxon won’t go bust next month unless the greens overthrow The Whitehouse, but who knows with a finance company? Anything can happen.
When deciding what stocks to buy, always consider if you’re in it primarily for the quarterly dividends, or for the long-term growth of your shares.
If you decide collecting dividends is for you, it’s a great way to earn passive income every financial quarter. You can also decide to reinvest these back into the company and get some tax breaks as a result.
So there you go. The first seven terms you’ll need to wrap your head around before you venture into the world of online financial trading.
Get with the terminology. It’s a little like law, if you don’t know what you’re agreeing to or signing, you’re going to get burned.
On the other hand, learn the game and its terms and master it and wealth you never dreamed of can be yours.
Desire. Decide. Persist.