6 Stock Market Terms That’ll Melt Your Brain (and What They Mean)

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If you’re brand-new to investing, all the terminology related to the stock market can be off-putting. Instead of learning what feels like a new language, you might feel overwhelmed and hold off on investing. However, many stock market and general investing terms are much simpler than they seem at first glance. If you keep an open mind, you might be surprised how quickly you can learn the lingo and gain confidence investing.

Here are some examples of stock market terms that you should know and aren’t as complex as they might sound.

Also see eight tips to invest in stocks for beginners.

Volatility

You might see headlines about stock market volatility or hear about the volatility of a particular stock, and while it might seem like something to fear, it’s not necessarily something to run from.

“The term volatility can often scare newer and even experienced investors because it is often associated with negative events, but the meaning itself is quite simple. Volatility means how much a stock goes up and down,” said Nicole Carlon, CFP, wealth management advisor at WiseOak Wealth.

And not all stocks are the same in terms of volatility. “Some stocks may be more volatile than others. This means the price of the stock will go up and down more often than one that is less volatile. It does not mean that one stock is better than the other, but that the value fluctuates more. It’s up to the investor how much fluctuation they feel they can handle,” Carlon explained.

Diversification

Another key term to know is diversification, as it’s typically an important part of managing risk.

“Diversification sounds to the average investor like a complicated strategy, but in layman’s terms it means not putting all of your eggs in one basket,” Carlon said. “Essentially, an investor would buy positions in multiple categories — stocks, bonds, real estate, etc. — instead of using all their funds to only buy one stock. The general concept is that if the money is spread into different positions and one does poorly, the others will hopefully do better to balance the account out.”

Investment Horizon

You might hear an advisor ask you about your investment horizon or see this term come up in contexts like retirement planning. The good news is that it’s a pretty simple term that typically aligns with certain investing practices.

“The investment horizon refers to the period during which you expect to keep your money invested before needing to use it. It can be short-term (less than a year), such as a down payment or a car; medium-term (a few years), like college expenses for kids in five years; or long-term (10-20 years or more), like retirement,” said Jon Knotts, chief investment officer at Expressive Wealth.

Knowing your investment horizon can help you plan your investment strategy. “The investment horizon helps you decide what kinds of investments to choose and how much risk you can take. For example, if you are saving for retirement in 30 years, you could take more risk than if you are saving for a house down payment in one year,” he explained.

Compounding

While many first-time investors think about how much stocks might go up over the next few months, the real secret to building wealth often depends on the power of compounding returns over many years, if not decades. 

A stock or fund might grow by a few percentage points one year, but this eventually can lead to exponential growth because each year’s returns are compounded, meaning that they’re building on top of each other. In other words, as your account balance grows, the same percentage return yields a higher dollar amount. For example, a 10% gain on $5,000 is $500, but if your balance grows to $10,000, the same 10% gain yields $1,000.

“The power of compounding allows an investor to have their investment grow just because they are invested in the first place,” said Stephanie Nanney, CFP, partner at Private Vista. “It’s like social media. As you gain followers over time, the more likely it is that additional followers will engage with your content and your reach/impressions grow exponentially.”

Dollar-Cost Averaging

Dollar-cost averaging might seem like a complex strategy, but many beginners do this without even realizing by nature of investing with each paycheck into a retirement account. Basically, it means investing the same amount at regular intervals so that whatever stock prices are at that time, you’re adjusting your average purchase price.

For example, you might invest $1,000 into a mutual fund with a $100 per share price, giving you 10 shares. The next month, if the price dropped to $90 per share and you invested $1,000 more, you would buy 11.11 shares. Together, your 21.11 shares would have an average purchase price of around $94.74. So if the fund went back up to $95, you’d be back in the green, even though you’d initially bought some shares at the $100 price.

“Dollar-cost averaging is so important because it takes the emotion out of investing as well as removing timing when to buy into markets. Usually, this happens through your 401(k) but can also be done by choosing an amount to personally invest on a regular basis,” Nanney said. “This allows you to buy more shares when prices are low without trying to time the market.”

Capital Gains

Lastly, beginners should understand what capital gains are before investing in stocks. 

“They are the profits that you make from your investment. A gain happens when you sell an investment for more than you paid for it. A capital gain is the goal, but investors will pay taxes on it. Investors should understand the tax consequences,” Knotts said.

The two main types of capital gains are short-term ones, which are “profits from investments you held for one year or less,” Knotts explained. Short-term capital gains, he said, are taxed at your regular income tax rate. Then there are long-term capital gains, which are those held for over a year and are generally taxed at lower rates, he added.

One bonus term to keep in mind related to capital gains is cost basis. “The cost basis is the total amount you paid to purchase an investment, including the purchase price plus any additional costs, such as broker fees or commissions,” Knotts said.

Understanding your cost basis is necessary to determine your profit (i.e., capital gain). Until you actually sell the stock, though, there is no capital gain, as no profit has been realized; there are just gains on paper.

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