There are two major ways to participate in the financial markets – you can either go the passive route or the active route. Investing is the passive way wherein you buy and own an asset and wait for the profit to generate over time. Trading is a more active way of engaging in the market, which aims to outperform standard, laid-back investing.
As a trader, you strive to become more profitable than traditional buy and hold investors. You don’t just wait for profits from the long-term uptrends in the market. You work your way to seek short-term price moves to gain profit during both rising and falling markets. CFD Trading and Forex Trading are just two forms, to begin with.
The most successful traders of all time include John Paulson, George Soros, and Paul Tudor Jones, among others. And of course, the best trading gurus didn’t gain mastery of how trading works and how to thrive in the industry overnight. They had to take the time to learn it. So before you dive into complex strategies, give your trading journey a head start by learning the basics – the essential jargons in trading.
Security, in the trade language, refers to a paper traded for some type of monetary value. It is a fungible and negotiable financial asset that represents an ownership right or position in a traded corporation by means of stock.
Bid and Ask
The “bid and ask” refers to a two-way quotation which determines the best price at which a security can be traded at a given point in time.
The bid, also called the bidding price, is the amount that a trader or investor agrees in order to purchase a certain security. It represents the maximum price that a particular buyer is willing to pay for a security. If such bid is accepted by the broker or market maker, then it is when the transaction takes place.
If bid represents the buyer’s maximum, the asked price represents the minimum price that a particular seller is willing to receive for the security.
For instance, you want to buy shares of a popular shoe brand. Your bid price, as a buyer, is $50.60 per share while the seller’s asking price is $50.90. For you to get that order, you have to pay that $50.90.
The basic principle is if you’re a buyer and you want to buy shares upfront, you have to pay the asking price. In a similar way, if you’re trying to sell shares upfront, you’re going to sell it for the bidding price. If the buyer and seller agree on a specific price for the security, then the transaction or trade occurs.
Spread (Bid-Ask Spread)
The spread is the difference between the bid and asked price. Given the previous example, the spread would be $50.90 – $50.60 = ¢30. The difference of ¢30 is what the market makers or the people in the trading floor get paid for to execute that order. The minute you purchase the stock in asked price, you’ll be losing ¢30. The minute you sell the stock at the bidding price, you’ll be losing ¢30 as well.
The spread is also a key indicator of the liquidity of the security or asset. The smaller the spread, the better the liquidity.
The order contains the investor or trader’s instructions to purchase or sell a security. The orders are made through a broker or a brokerage firm and are often placed over the phone or online. Orders are categorized into various types, including the market order and the limit order, which allow investors to put restrictions and influence the price and the timeframe at which the order can be executed.
Market order, also known as the “unrestricted order”, is the most common type of order used to trade a financial security. A market order is made through a broker to be executed immediately at the best available current market price. If the person placed in the order does not specify any restrictions on the price as well as the timeframe when the order can be completed, then by default the order is considered to be a market order.
Unlike market order, a limit order has certain restrictions. With a limit order, the trade is not executed immediately but is completed when the ideal price is met. A limit order is often set to a better price than the currently available price. It allows the investor to limit the length of time their order can be completed.
Liquidity refers to the high volume of activity taking place in the market. It shows the degree to which a currency, stock, or asset can be sold or purchased immediately on the market with the prices remaining stable.
Market depth is closely related to liquidity and volume of a security. It refers to the abilIty of the market to sustain large market orders without altering the price of the security. If the market for a stock is “deep”, chances are there will be an adequate volume of pending orders on both the bid and ask waiting to be executed.
Author Bio: Sophie Harris is one of the resident writers for FP Markets CFD Trading, a CFD and Forex Trading provider in Australia with over 12 years industry experience serving global clients. Writing informative content about business and finance is her cup of tea.