7 Jargon Words Explained in Finance — Brokerage Edition
Opening a brokerage account can be intimidating, and even more so when the words and jargon on the screens sound more like calculus than dollars and sense. We’d like to break down the 7 most common concepts and jargon words you hear thrown around by brokers and your Wall Street buddies.
Market Order
The Buy and Sell buttons in a brokerage account are by default powered by market orders. A market order is the first order type you encounter when you open a brokerage account. This order is simply saying I want to “buy” or “sell” right now, at the best prevailing price. A market order guarantees execution, but not the price. Meaning that your broker will try to sell or buy all the shares you specified first before guaranteeing a final price. This is important because the price that you are shown by your broker when you click buy or sell, is not necessarily the same price your order will get filled at.
If we wanted to buy a stock that wasn’t very liquid — a stock that didn’t trade that many shares in a given day, the next best available price to buy is probably costlier than what we see on the screen. But since the majority of individual investors, especially younger ones, are trading liquid technology stocks like GOOG or AAPL that exchange hands a lot during the day, using market orders for these stocks is often fine (as long as you have a rule or strategy behind your market order!)
Limit Order
The golden order type. The dark horse. The order type to rule them all. The first kind of trigger. A limit order is an order to buy or sell a set number of shares at a specified price or better. It guarantees price over execution, meaning that you might not sell or buy all the shares that you intended to at a given time. Limit orders ensure that you do not pay a penny more than you are willing to.
For example, a limit order to buy AAPL at $90 means you will buy AAPL at $90 or better for the amount of shares that you want. Limit orders are especially useful on a low-volume or highly volatile stock environment, when you can guarantee price over anything else. At the end of the day, limit orders are also conditional statements, IF this then THAT. The goal of limit orders is to give investors more control over trading costs so they can protect profits and limit losses without having to monitor their portfolios continuously.
Stop Loss Order
A stop-loss is designed to limit an investor’s loss on an investment. It guarantees that you will get out of your investment or positions once the price you set has been triggered. As an example, if you bought 1 share of AAPL at $120 and you are willing to lose 25% of your investment, you would then set a stop loss order to sell at $90. This means that when $90 is the best price in the market to sell, you will now enter into a market order (see above) to sell all your AAPL stock. Most importantly, a stop loss allows decision making to be free from any emotional influences. People tend to fall in love with stocks, believing that if they give a stock another chance, it will come around. This causes procrastination and delay, giving the stock yet another chance to dip lower. In the meantime, the losses can mount. Stop loss orders are not perfect because of the market order that powers them, but they are generally good investing practices to start learning.
Capital gains — long vs short term
A capital gains tax is a type of tax imposted on capital gains incurred by individuals and corporations. Capital gains are the profits that an investor realizes when he or she sells an investment they own for a price that is higher than the purchase price. Capital gains taxes are only triggered when an asset is sold (or bought in case of shorting), not while it is held by an investor. An investor can own shares that go up in value every year, but you will not get tax on those gains until you actually sell those shares and realize a profit.
On stocks your gains are divided into 2 important categories, long term and short term capital gains. The difference between the two is whether you’ve held the stock for more or less than one year. Long-term capital gains are taxed at a lower rate than short-term gains, this is to incentive the economy into a Warren Buffet type of investing style, long haul value investing. It does not reward the speculator for intraday profits.
Short term capital gains however, will be taxed at a normal income tax rate of up to 35%. Whereas long term capital gains is generally around 15% tax rate. That’s a pretty big jump. Weather you’ve held a stock for more than a year should definitely play a big role into your strategy, as it’s already hard enough making 15% in the market, let alone giving it away in taxes! (In the future at Trigger, we will be able to trigger orders based on tax events — yay)
Shorting
One of the most talked about, yet still mysterious strategies and jargon on investing. Shorting an asset, most commonly in brokerages as a stock, means you are selling a stock you do not own. Yes, you can sell something you don’t own, by borrowing shares from your broker. You do this because you think the share price of the stock will drop in the future, hoping to buy back those same shares you borrowed at a lower price and make a profit (deducting the interest you own on your borrowed shares).
The mechanics of shorting require a dedicated post just on its own, and we will make sure to explain all of it in detail!
Margin
A margin account is an account offered by brokers that allows you to borrow money to buy or short stocks. It’s essentially giving you a credit card for the stock market, by taking out loans from your broker. If you have $5,000, you can buy $10,000 in stock by borrowing the $5,000 from your broker. If the stock you bought goes up, you can use your profit to pay back the interest and principal on your broker. BUT if it goes down, your losses could be multiplied, since you owe money to your broker plus interest as the stock keeps going down. If your broker deems that your borrowing is of too much risk for them and you, it might issue a notice called a Margin Call, explained as the next jargon word.
Margin Call
Remember that movie Trading Places and the infamous orange juice concentrate trading floor scene? That was the hollywood version of a margin call.
The government actually requires brokers that you always have enough money to cover some minimum margin, usually enough cash or stock value in your account to equal 25% of the total price of the stock you borrowed. So in the example above, if you borrowed $5k to buy $10k worth of stock and the value of the stock dips to $6k, you’ve lost $4k leaving you $1k in margin account ($5k-$4k). The rule says you need 25% of the stock you borrowed (25%*$6k) is $1500, so you don’t have enough of that on margin! You either need to deposit $500 MORE in your account, or your broker can actually sell stocks unrelated in your account to cover the $500. Worst of all is they can sell anything they please without telling you. This is why people dread the margin call, it’s not only risky, but can leave your account and your finances in ruin.
