Basic Terms #primers

First in the #primers series, some very basic definitions so that we can be on the same page. Many of you can probably skip over this:

Markets are no different than what your instinct tells you. Just like all markets, it includes market participants (buyers and sellers), dealers (who help facilitate the transaction), an exchange, and regulators.

In a market, the asset or security is what's traded (bought and sold).

Most markets set the asset price in a range between the bid and the ask. In this way, it can be thought of like an auction with many different participants. The bid is the highest price at which someone is willing to buy the security, the ask offer is the lowest price at which someone is willing to sell it. No different than in an eBay auction, if demand for the asset increases, buyers will be willing to pay slightly more to find a seller, increasing the price. If people decide that they need to get out of a position now, they will accept a lower bid, driving the price lower.

Bullish refers to the opinion that an asset or market (for example, a stock like Apple) will go higher in value. Bearish refers to the opposite — the opinion that an asset or market (for example, a commodity like oil) will go lower in value. The bulls are buyers; the bears are sellers.

If I say "I'm bearish Tesla," this means that I believe Tesla stock will go down over some period of time. I could also say that "I'm short Tesla." A short position bets against a market by selling it first, then agreeing to buy it back later (short selling, shorting). Since, as a short, you believe that the stock will go lower, you will be buying it back at a cheaper price, making a profit. Tesla bulls will say that they're long Tesla – a long position just means they own the stock.

A hawkish central bank is focused on inflation. Hawks favor raising interest rates to restrict the velocity & supply of money. A dovish central bank is focused on economic growth and maximizing employment. Doves seek to lower interest rates and maintain a loose monetary policy which increases the money supply. Dovish policies are, broadly speaking, inflationary (but not necessarily) because they spur economic activity and increase the velocity of money.

Liquidity is the ease at which an asset (a stock, a Treasury bond, a bar of gold, a barrel of oil) can be converted into cash. It is the ease at which it can be bought or sold. A market with lots of participants is a liquid one; the opposite - a market without many participants - is said to be illiquid. Liquidity can be thought of as available "cash" in this way.

Volatility can be a measured quantity (VIX, implied volatility, MOVE, etc.) but, most of the time, we think of it as equating to uncertainty. Illiquid markets are more volatile than liquid ones, and have wider bid-ask spreads.

Equities refers to stocks.

Derivatives are financial contracts whose value is dependent on an underlying asset (ex: oil), group of assets (ex: Tech stocks), or benchmark (ex: interest rates like SOFR). Derivatives are, by far, the largest market, estimated at over $1 quadrillion ($1,000 trillion) in notional terms, and many are derivatives of other derivatives (swap derivatives, options on futures contracts, etc.). Derivatives are often used as hedges.

A hedge is an offsetting position in an asset or investment that reduces the risk of an existing position. A hedge is therefore a trade that is made with the purpose of reducing the risk of adverse price movements. For example, investors used to hedge their stock investment by buying VIX derivatives (which increase in value as volatility increases). This is not common today. More often, hedging a stock investment includes buying put options to protect (hedge) the downside.

Options are common and important derivatives that we will explain in greater detail soon. They are extremely relevant today.

#primers

[As a side note, we decided to release these primers on the weekends only. No more than three or four per day to prevent the spam effect].