Ever hear people use words relating to the stock market in a conversation or in the news? Or you attended an investment training program where stock market terminologies were used and you were wondering what they meant? Well, wonder no more. We have you covered!
Here are some terminologies that will help you understand the stock market better:
Capital Asset Pricing Model (CAPM): The Capital asset pricing model is a model that provides a framework to determine the required rate of return on an asset. It also indicates the relationship between return and risk of the asset.
Arbitrage Pricing Theory (APT): The act of taking advantage of a price differential between 2 or more markets is referred to as arbitrage. Arbitrage pricing theory describes the method of bringing a mispriced asset in line with its expected price.
Efficient Market Hypothesis (EMH): The efficient market hypothesis is defined as a situation whereby all information affecting a stock is immediately and automatically reflected in the price of the stock, including the risks involved. No one can successfully beat the market with superior information. Why? This is because the market is perfect, with no taxes, transaction costs and where investors react the same way.
Random Walk Theory: This theory states that the price of a security at any point does not give an idea of what it would be in the future. There is no serial correlation between security prices over time, either in terms of size or period. The theory basically states that the market has no memory.
Fundamental Analysis: Fundamental analysis is a security analysis technique that attempts to determine the intrinsic value of a stock by analysing the economy, industry and the company.
For the Economy, the GDP, inflation, foreign direct investment, government policies, interest rate, and a lot of other factors are all analysed. For the Industry, the companies in the industry, the market leader and how tough the competition is. For the Company, management, revenues, profits and cash flows, company product amongst other things, are analysed.
Technical Analysis: Technical analysis is a security analysis technique used for forecasting the direction of prices, through the study of past market data, primarily price and volume. While fundamental analysts examine earnings, dividends, new products, research and the like, technical analysts examine what investors fear, or think about those developments, and whether or not investors have the wherewithal to back up their opinions.
Exchange Traded Funds (ETFs): Exchange traded funds are new securities that track indices or an index. They track commodity prices, or a basket of assets but they trade as stocks.
Bell Weather Stocks: Bell weather stocks serve as a gauge of general market performance, or general economic performance.
Price Discovery: Price discovery is the process of determining the price of an asset in the market place through the interactions of buyers and sellers. Price discovery is different from valuation; it is the process which involves buyers and sellers arriving at a transaction price for a specific item at a given time.
Market Maker: A market maker is a firm/broker or dealer that stands ready to buy and sell a particular stock on a continuous basis at a publicly quoted price. The market maker must also quote bid and ask prices for the stocks on which it makes market, and it makes a profit on bid-ask spread on such stocks. The market maker makes profit on the price differential between bid and offer prices.
White Anting: This is a situation whereby companies in the stock market report unsustainable high profits, usually in a regime of high interest rates. It is also known as Paper Profit.
Capital Trade Points: Capital trade points are muster points (where people gather) for people in rural and not so monetized environments to have the opportunity to participate in the business of securities trading.
A Scrip: A scrip is a dividend in kind in the form of extra issues given to existing shareholders in lieu of cash dividends, or sometimes in addition to cash dividends.
Frontier Markets: Frontier markets are markets with low levels of liquidity, turnover, transparency and few institutional controls. They are also characterized by high volatility. Examples of such markets include: Nigeria, Ghana, Cape Verde, Botswana, and Cambodia.
Santa Claus Rally: Santa Claus rally is a situation that occurs when prices rise in January after stock prices have fallen in December to finance consumption for celebrations.
Monday Effect: This is a theory that propounds that the market on Mondays would tend to follow prevailing trends of the previous Friday.
Cockroach Theory: This theory states that once there is a bad piece of information coming to the stock market, chances are that it would be followed by a lot more.
Contango: A contango is a settlement that involves a buyer of a security delaying payment for that security until the next settlement date. He must pay a contango interest for delaying. The buyer usually delays, expecting the stock to go higher so that he can make profit. For someone to do this, he must be a good forecaster. This usually occurs in a bull run.
Backwardation: Backwardation is a situation whereby a seller delays delivery until such a time or date of the next settlement date, usually 7 days. This usually occurs in a bear market where the seller expects prices to drop further. For example, if the price is N10, he hopes it falls to N8 so he can buy at N8 and deliver to you at N10.
Short Selling: Short selling is a situation where the seller doesn’t own the stock, but he borrows or intends to buy later. He anticipates that the price would drop further and delivers at a price less than what was agreed.
Margin Trading: Margin Trading is a situation where an investor buys a particular security through his broker but only puts down about 10-20% of the value of the stock, while the remaining is borrowed on behalf of the investor, in the hope that money will be made if the price rises.
This article was first published on Nairametrics on December 9, 2015.