We’re only going to tell you what we think is absolutely essential about these ideas. You can go pretty deep on some of these concepts, and we encourage you to do so later on if it interests you, but for our purposes, here’s what you need to know.
Shares and stock are the same thing: ownership of a piece of a company. Bonds are corporate IOUs. All of the above are securities. There’s a chance you find the offering of this information as insultingly basic, but there it is regardless.
Supply and demand. These are perhaps the most fundamental concepts in all of economics, and they are the absolute heart of a market economy. They are the actors in the story you are watching when you’re looking at your screen. Supply is how much of a product a market can offer. Demand refers to how much of a product is being sought by buyers. Quantity demanded is how much product people are willing to pay a certain price for. The demand relationship is the relationship between price and quantity.
Price represents a shared opinion of value at the moment of transaction. The disagreement is in each individual’s belief about where the price is headed. Being the one whose belief proves to be true more often than it proves to be untrue is headed more often than you fail to is the name of the game.
The ask and the bid. The inside bid is the highest price you’re allowed to demand when selling a stock as a market order. The inside ask or inside offer is the lowest price at which you can by a stock if you want to buy at the market price. The spread is the difference between those two prices. These numbers appear as bid first like this: “Bid: 22.87, Ask: 22.88.”
Decimalization refers to the market adopting the use of decimals rather than fractions of a dollar. Before April 9, 2001, the smallest fraction allowed was 1/16, so the smallest tick in price was $0.0635, and since then, the smallest movement a price could make, it’s been $0.01. This changed the nature of market making by trimming the fat on the distance between the bid and ask prices.
A market order or unrestricted order is an order an investor makes through a broker or brokerage service to buy or sell at the best available current price. It doesn’t contain any restrictions on price or time frame, so this is the default option and the most likely to be filled. But this increased likelihood can come at a price.
Slippage refers to the difference between the expected price of a trade and the price when it’s actually executed. This is most common during periods of higher volatility and on securities with low liquidity and wide spreads. It also happens when large orders are being executed and there isn’t enough interest at the desired price level to maintain that expected price, so the price is lowered in order to meet the new level of interest. Slippage can be a positive or negative movement—it refers to ANY difference between expectation and actual price at the moment of transaction.
If a stock is quoted at a bid/ask of $30/31, with 100 shares at the bid and 100 shares at the ask, and a trader places an order to buy 200 shares, the first 100 shares will be executed at the ask ($31), and the remaining 100 shares will be executed at whatever the ask prices are for the sellers of the next 100 shares listed at the ask price. This moves the average price for the 200-share order up, and the difference in price is the slippage.
Slippage should give you some idea as to how quickly prices change. We aren’t talking about trades being executed minutes later; this happens in seconds, even fractions of a second.
The best way to avoid being hurt by slippage is to avoid market orders whenever they aren’t really necessary, opting instead for limit orders.
A limit order is a take-profit order placed with a broker to buy or sell a set amount of a security at a specified price or better. There’s a possibility it may not be executed if the price you set cannot be met during the period of time the order is left open for. The length of time an order is left outstanding before cancellation is also up to you.
If a stock is trading at $20 and you want to buy at $18, you can place a limit order and your order will be filled when the stock reaches $18. If you own a stock trading at $20 and you want to sell at $22, you place a limit order to do so and the order is executed if and when the price is met.
Limit orders guarantee a trade will be made at a particular price, but it’s likely your brokerage will charge you more in commission fees for the privilege, and your order might not be executed at all if your set price isn’t reached. Execution is not guaranteed, but you won’t miss the opportunity to buy or sell at the target price point if it is dealt in the market.
Contrast limit orders with stop loss orders. These ensure that a transaction will be executed only when price falls to a particular amount, at which point stop orders essentially become market orders.
They can also be used as sort of a safety net for profits you’ve made. If you purchase stock at $50 and it reaches $60, setting a stop loss at $55 will prevent your gains from being wiped out entirely should the price fall back to $50 or worse. These are handy if you’re not able to monitor the stocks closely.
A commission is a service charge paid to a broker in return for handling the purchase or sale of a security. This is how full-service brokerages make the majority of their profits. The rates vary widely from brokerage to brokerage. If you’ve ever seen Trading Places starring Eddie Murphy, this is basically the ONLY part of trading the old brokers explain to him about commodities before he makes a fortune. Sadly, it’s much more complicated than that.
Commissions differ from fees in that a fee is a flat rate, whether a dollar amount or percentage of assets under management (AUM), whereas a commission is paid based on selling investment products like funds an annuities. The possibilities for conflicting interest here is obvious.
Margin is a term used to refer to a few different things, but for our purposes, we’ll be using it to refer to a loan a broker gives you.
When you open your an account with a broker, designate it as a margin account (usually referred to as a “50% margin account”). The broker will match the funds in your account. If you start with $5,000, they will match you, effectively giving you $10,000 to work with.
Don’t get too excited. Don’t get excited at all, really, ever. This is a good place to start learning emotional discipline. You need to be careful with these margin accounts. Forget this money even exists until you’ve got enough experience to handle it, which won’t be for a while.
Quick, very important aside: If you plan to make four round trips or more during a five-day trading period, the SEC requires you keep a $25,000 minimum balance in your account. You’ll be starting slowly, so you might not need this right away, but four entries and exits in five days isn’t very many, so you need to budget for either slowly working your way up to this or starting out with this much right away.
A gap is a break in a stock’s chart occurring when the price of a stock moves suddenly in either direction without any trading occurring. This can be due to a buying or selling spree, or an earning announcement, some sort of news release, or a change in analyst outlook.
This commonly happens from day to day. Stocks don’t necessarily close one day and open at the same price the next. Market makers and specialists adjust the price according to the orders waiting to be filled when the market opens.
Price is sensitive to human opinion and emotions, and whether or not a particular market is open, the forces acting on price never stop. An experienced trader can exploit these gaps and take quick profits off price corrections, but open gap trading isn’t a game for novice investors.