Common Share Market Terminology for Beginners - Part 2
Share Market Terminology for Beginners - Part Two
Find below some of the most common share market terminologies explained for beginners. Click here to read part 1 of the Wise-owl Share Market Terminology series.
A margin account allows investors to trade on borrowed funds. This service is usually offered by brokerage firms. Similar to a mortgage loan, shares that are bought on credit are used as a collateral and an interest is charged periodically.
Market Capitalisation is the total on market value of a company. It is calculated by taking the company’s total shares outstanding and multiplying it by the current stock price. As the market value of the stock regularly changes, so does the company’s market capitalisation. Among other things, the market capitalisation of a company is an important factor in qualifying for the main indexes such as the ALLORDS or ASX200. Companies with a market cap of less than $3bn are often categorsied as small to mid-cap stocks. For more information on small and mid-cap investing read Investing in Small Mid-Cap Stocks.
A market order is placed through a broker to buy or sell a stock immediately at market value or the best available price. The order is likely to be executed as it doesn’t contain any restrictions. Market orders are generally only recommend for high volume stocks, as buying stocks with low liquidity (low traded volume) through 'on market' could result in a large spread.
The most common type of share is an Ordinary Share, also known as a common share. An ordinary share represents equity ownership in a company, carries one voting right per share and is usually eligible for dividends. Should a company wind-up and distribute its assets, ordinary shares are the last in line behind bondholders and preferred shares.
There are different types of preferred shares with different characteristics, however as a generalisation, preferred shares are a combination of debt and equity. Preferred shares are entitled to assets and dividends ahead of ordinary shares and usually have a fixed dividend rate. Preferred shares have voting rights, however are usually restricted to specific circumstances or particular resolutions.
The price to earnings ratio, also know as P/E ratio, is a multiple that indicates how much investors are willing to pay in order to receive one dollar of the company’s earnings. It can be calculated by Market Value per Share/ Earnings per Share. The higher the PE ratio, the more the investors are willing to pay for its future earnings and vice-a-versa. This ratio is also called the price multiple or the earnings multiple.
When a company wants to raise extra capital (e.g. to pay off its debt or expand its operations), it can choose to offer a rights issue. Through this method the company can issue rights to existing shareholders with the right, but not the obligation to buy additional shares. The price at which the new shares are offered comes usually at a discount to its current market price. The number of additional shares are set on a pro rata basis, whereby an investor can buy shares at a certain proportion of his/her holdings.
The risk to reward ratio is a measure that indicates the amount of risk an investor has to take for every dollar earnt. This can be measured through indicators like alpha, beta, Sharpe ratio and r-squared. Alpha measures the return on an investment against a market index. The beta measures the risk on an investment compared to a market index. The Sharpe ratio measures the excess average return earned over the risk free rate for every unit of volatility. R-squared is a measurement of each stock’s movements in comparison with a market index as a benchmark.
The statistical tool standard deviation is used as a risk measure and is also known as historical volatility. The Standard Deviation is calculated by finding the square root of a portfolio’s variance. A portfolio’s variance measures the divergence of a stock portfolio’s returns from a certain index.
Stop Loss Order:
When an investor buys a stock, a stop-loss can be put in place to protect a certain position from downward movements of the security. The stop order instructs the broker to automatically sell the stock if it reaches a certain price. The stop-loss is designed to limit the investor’s loss if the stock declines. For example, if an investor purchases a stock for $1.20, a stop-loss can be put in place to automatically sell the stock if falls to $1.00, thus limiting the investors loss to $0.20 per share. A stop-loss can take the emotion out of the selling process or be useful if the investor needs to spend some time away from the stock market.
Technical analysis is a technique of stock analysis which generally analysis historical price patterns in a stock price graph. This method uses historical performance of a stock to predict its future trajectory. 'Technical analysts' look for specific technical patterns in a historical price graph. It usually does not attribute much weighting to the fundamentals of a company, index or market.
The term ‘breakout’ is usually used in technical analysis and refers to a technical pattern when a stock’s price moves higher than its resistance level. At this point the stock often experiences higher volumes as it is considered as a bullish sign amongst technical traders. traders assume that a stock continues to trade higher after breaking out of its resistance level.
Volatility is the divergence or variation of stocks and indices from an expected level. The divergence can be upward or downward depending on supply and demand from the market. Volatility also measures a security’s stability as higher volatility generally implies higher risk.
Yield usually refers to the income received from an investment and is often used in conjunction with dividends or distributions. While dealing with stocks, the term ‘yield’ is often used interchangeably with ‘dividend yield’. A dividend yield is expressed in percentage terms and indicates 'how much' dividend was earned for the price paid on each share. The annual yield is calculated by 'Annual Dividends Per Share/Price Per Share'.
Click here to read part 1 of the Wise-owl Share Market Terminology series.