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The stock market, like every other specialized area, has it’s own language. Some of the stock market terms can be confusing – even to highly educated people who have been investing for years. If you don’t think so, just tune into Power Lunch on CNBC and really listen.

Although I’ve been in the market since 1996, some terms still confuse me. These are often ones I don’t use much, but some are fairly common!

Here are some of the terms that confuse. Some of them, I just never can remember which one is which (like Bear and Bull – to me they are both just animals). Others are (in my mind) very esoteric and somewhat hard to understand – or are slight twists on other terms, with a tiny difference in meaning.

Bear with me while we muddle through these together.  Some day we will explore using them!

Bears and Bulls.

A bull market is a rising market. A bear market is a declining one. The terms have been around for quite some time and refer to the nature of the animals. Bears attack by rearing up on their hind legs and swiping down. Some say that bears are somewhat sluggish. Bulls attack by putting their head down and swinging their horns up. Some say that bulls are more spirited.

What is confusing? Probably nothing, but for some reason, I always have to stop and think about which is which!

ETF.

Wall street players are continually inventing new types and combinations of investments. Exchange Traded Funds (ETFs) are one of these inventions. The first ones surfaced around 1993, but didn’t become widely used until the 2000′s.

A SPDR (spider) is an example of an ETF. SPDR stands for Standard and Poor’s Depository Receipt and is an exchange traded fund that holds American Depository Receipts (ADR). To allow Americans to invest in the foreign stock markets, banks hold the stock certificates and issue deposit receipts to investors wanting the securities.

An exchange traded fund is a fund that holds assets in stocks, bonds, commodities and etc. The fund trades during the day on the open market – it’s fund price rising and falling with demand that day.

Differences between ETFs, mutual funds and closed end funds.

ETFs are similar to mutual funds in that they are composed of stocks, bonds, etc, however, they are governed by different Securities and Exchange Commission (SEC) rules that allow them to trade like a stock, instead of selling at the same price (yesterday’s closing net asset value) all day.

A closed end fund is a fund that is composed of underlying stocks, bonds and etc as well. However, there are a set number of closed end fund shares that can be bought (determined when the fund is started). There is also a set date when the fund will be liquidated and money returned to the investors. You can’t get your money out by redeeming fund shares (as you can in a mutual fund). In order to get your money out before the fund liquidation date, you sell them on the market to other investors that want those shares – hence the price rises and falls with demand. These too have their very own SEC rules

Futures.

You want to buy corn now, before it has grown and been harvested, because you think it will be scarce and higher priced in late summer. The farmer down the road wants to sell corn now, because he knows that all of his farmer friends across the mid-west are also planting corn and he thinks it will be too plentiful – driving the price down in late summer. So the two of you draw up a contract, which formally obligates you to buy the corn (and maybe accept delivery of a ton or so in late summer) at a certain price and the farmer to sell the corn only to you for that price in late summer. (Note that this is a simplistic view of futures!).

You as the buyer, are ‘long’ in the contract – you think the price will go up in the long term. The farmer as the seller is ‘short’ in the contract – he thinks the price will go down in the long term.

A futures contract is a standardized agreement between two parties but it is mediated by a futures exchange institution (such as the Chicago Mercantile Exchange). This institution requires the parties to put up a margin (a certain amount of money or assets). The standardization and use of the exchange institution allow the contract itself to be very easy to sell.

Between now and late summer, other people are also betting on the price of corn in late summer. Every day, standardized contracts are drawn up at a different ‘future’ price. The futures exchange figures out the difference between the price you agreed to pay and the future price on the market today and gives or takes money from your margin account to bring your price up to or down to the current ‘futures’ price. This is called marking to market.  It means that the price in your contract is really not the price you pay on the expiration date.

The product you take a futures contract on does not have to be corn or any other commodity. It can be a financial asset or even a short term interest rate.

Long and Short.

Being ‘long’ or in a ‘long position’ means that you expect the price of the asset in question to rise. If you own a stock, you are ‘long’ in that stock.

If you purchase an option (see below) to buy a certain stock in the future for a price you set now, you think that the price will rise in the future.

Being ‘short’ or in a ‘short position’ means that you expect the price of the asset in question to fall. You won’t be owning the stock – you will be trying to dump it before the price falls.

If you purchase an option to sell a certain stock in the future for a price you set now, you think that the price will fall in the future.

Limit order.

Lets say you own Disney stock and want to sell some of it. However, you don’t want to take just whatever the market is buying Disney for today – you want to get at least a certain price. To do that you enter a ‘limit order’ which limits the price at which your stock can be sold.

For instance, say Disney is selling today for 44.95 but you want to sell for 46.00 a share. You can call up your broker and say I want to sell xxx shares of Disney with a limit order at $46.00 a share. You then tell the broker how long you want the order to be in effect. Good until cancel lengths usually last about 60 days. If the price goes up to $46.00 a share anytime within the next 60 days, your stock is sold.

Options.

You can buy a contract that gives you the right to purchase a security or other asset in the future at a specific price. This is called an option.

Let’s say that you think Coke shares will go up due to inflation. Lets say it is selling for $61.28 a share today. You think it will be selling at 70 in 2 months. You can buy a contract that gives you the right to buy Coke shares at $62.00 in 2 months (when it is hopefully selling for $70 a share). In 2 months, you ‘exercise’ your option – buy the shares for $62 and then sell them right away for $70 – making $8.00 a share less the cost of the option contract, fees, taxes and commissions.

You have a ‘call’ option (because you will call the shares in when it comes time). You are ‘long’ in the option (because you think the price will go up in the long term). You are called the ‘holder’ of the option (because, hey, you are holding it!)

You can also buy a contract giving you the right to sell a security or other asset in the future at a specific price.  This is also called an option.

Lets say that you think Coke shares will go down due to competition with Pepsi. Coke is selling for $61.28 a share today. You think the shares will be selling for $50.00 a share in 2 months. You buy an option to sell Coke at $59.00 a share for the next 2 months. The price drops to $50.00 a share. You buy in the open market at $50.00 a share and then exercise your option to sell at $59.00 a share – making $9.00 a share less the cost of the contract, fees, taxes and commissions.

You have a ‘put’ option (because you will have to put the shares into the buyers hands if the option is exercised). You are ‘short’ in the option (because you think the price will go down in the long term). You are also called the ‘holder’ of the option (because, hey, you do hold it).

If this options business sounds confusingly similar to a futures contract – you aren’t alone! The difference, as I understand it, is that the owner of the options contract is not obligated to execute the option, but the futures contract owner is obligated to do what the contract says.

Confused?

These are some of the stock market terms I find confusing. Hopefully I haven’t confused anyone further.  Just wait until another post – when I try to explain VIX to myself and to you!

All of you investor gurus, if I have anything not clearly stated, please please comment!

Sources:

• Wikipedia
• Vanguard
• Investorwords

Last year (2011) the stock market fulfilled some of the longstanding folklore sayings which some believe are predictors of market activity.

What are these sayings and should you pay heed? Since I’m trying to get my 401K proceeds re-invested in my IRA, I’m particularly interested in some of these and decided to explore them and report back to all of you.

Sell in May and go away.

The idea of this bit of folklore is that the market does best in the months of October through May so if you sell in May you are getting a higher price and can then buy back at a lower price after the market dips through the summer.

Charles Biderman, in Forbes, reports that for the past TWO years, stock markets dipped following May and he anticipates this year following suite. On the other hand, Alex Dumortier, at the Motley Fool shows us two versions of historical data analysis that proves that buy and hold strategies are more successful than selling in May and re-purchasing in October.

However, there is also folklore which says that in a presidential election year, the market will go up, even after May – because the incumbent wants to get re-elected and will do anything and everything to make sure the economy is doing well. This is called the Presidential Election Cycle Pattern.

Why do I care? I want to buy some stocks, but they are at their personal best right now and I’d like to get them at a lower price. Since it is already mid-May, I probably will set some buy limits (name a price at which I want to buy the stock) with my brokerage firm and let them ride (i.e. set a ‘good until cancel’ buy limit). So far this month seems to be living up to this saying!

Sell in the Santa Claus rally.

This is a rise in the price of stocks occurring in the week prior to the beginning of January. The rise is attributed to multiple influences, such as making sure certain transactions happen this calendar year for tax purposes, anticipation of the “January effect” (see below), people investing their Christmas bonus (wait, do they still give those??) or fund managers preparing their holdings for the annual reports (changing out the stocks they hold to make sure the annual reports look good to investors – called window dressing).

If you need to sell, watch for the rally starting the last week of December. If you need a capital loss, sell your losers before that!  I’m hoping to lessen a position in one particular stock to limit risk so I will be watching to sell on a profit.

Beat the January effect.

Prices rise in the month of January, theoretically because individual investors sell in December to take gains or losses for tax purposes, then buy back in January. I have trouble with that theory because I don’t believe that individual investors have that big of an impact on the market anymore.

As goes January, so goes the year.

If we have a rising market in January, the market will be up at the end of the year.

According to the Wall Street Journal, “In years when the Dow has risen in the first month of the year, the median rise for the rest of the year is 10.4%. In years when the Dow has fallen, the median rise for the next 11 months is just 0.28%. “

The markets (at least the S&P) did finish up about 4% in 2012.

The market hates uncertainty.

Although nothing is ever certain, when there is turmoil in the economy or in political or other situations, the stock market can be affected. In 2011, we had a roller coaster ride up and down and all around with stock and bond prices bouncing all over the place.

Uncertainty in the world and US economic situations were blamed. Political turmoil, financial crisis, terrorist strikes, war and even civil disobedience can trigger reactions in the market. Waiting to buy on a dip caused by uncertainty is one way to chase lower prices.  These days, its one that isn’t too hard to implement!

Avoid buying the dividend.

A dividend paying company first declares the dividend (Declaration date) – which causes them to set aside the funds to pay the divided and lets the world know that they will be paying one.

Then the company sets the date by which you have to own shares to get the dividend (Record date – you have to be an owner of record to get the dividend). After this the stock trades without the dividend – meaning that if you buy the stock after this date and before the payable date, you don’t get this dividend. This is called the ex-dividend date or period (ex meaning without).

When the dividend has been declared and is in it’s ex-dividend period, the price of the stock usually drops to compensate for the dividend to be paid out.

Finally the company actually pays the dividend to the shareowners of record (Payable date) and then the cycle starts all over.

If you buy a stock after a dividend declaration has been made, but before the ex-dividend period, you will receive the dividend – however the stock price will fall because the market understands that the company is shedding some income which it could have used to grow. You will receive a dividend. You will have to pay taxes on the dividend (unless of course you hold the stock in a tax deferred account) and the price of the stock will drop after you buy it.

Why not wait for the stock price to drop,then buy it during the ex-dividend period. You get a cheaper price and avoid the income tax penalty.

Do you believe in these folklore sayings?

I’m certainly not an investment expert or professional, so don’t base any investment decisions on me. I tend to think that folklore has some validity, and its ‘truths’ may actually be true about half the time!

The bottom line for me is to know what allocation I want, research the types of investments and explore the strengths of individual companies before investing. While I don’t ignore price and timing, I don’t pull the trigger on making or selling an investment based on them either.

What Market folklore has merit in your mind? Have you heard other sayings?

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