Learn How to Trade Profitably

By John Pontikas and Brian Dibbins

Chapter three

Trading Concepts and Jargon

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This chapter describes some trading concepts and jargon including a brief explanation of markets such as the all ordinaries, an explanation of how call and put options work, the terms 'long' and 'short' and fundamental and technical analysis.

Some Concepts and Jargon Explained

This document is not intended to be a complete guide to trading.  However, people new to trading may find it useful if we pause a moment to briefly explain some basic concepts and jargon.

Markets: There are various markets around the world.  Australian readers may already be familiar with the Australian Stock Exchange (ASX), and the stocks, options and other instruments that may be traded on it.  There is also the Sydney Futures Exchange (SFE) on which one can trade various futures including the Share Price Index (SPI 200), or one may wish to look at trading international indices or currencies (Foreign Exchange or FOREX).

 The “All Ordinaries”: One will often read or hear news reports providing a summary of the daily movement of the various stock markets, such as the Dow Jones, Nikkei, FTSE and Hang Seng.  Each of these indices is made up of the major stocks in their country.  In Australia, it is usually the ‘All Ords’ index of the top 500 Australian stocks that is reported (code XAO).  The XJO represents their top 200 stocks, and so also helps to indicate the overall direction of the Australian market.

 Options: Exchange Traded Options (ETO’s or just ‘options’) are probably the most well known form of derivative, so-called because they derive their price from the underlying stock price.  Every option provides leverage over a specific number of shares (usually 1,000 on the ASX, or 100 in the US) in a particular stock, at a specific price (the strike price), and is valid until a specific date (the expiry date).  There are two types of options, “Calls” and “Puts”.  The buyer (or taker) of an option pays a premium to the seller (or writer) of an option for the right, but not the obligation to exercise that right either up until the expiry date (for American style options) or on the expiry date (for European style options).  A Call option gives the taker the right to buy the writer's shares at the strike price, while a Put option gives the taker the right to sell their own shares to the Put writer at the strike price.  There are many strategies that can be adopted when trading options, and the ASX website (for example), lists many of these.

 Going “Long” or “Short”: New traders may be surprised to learn that one can not only make money when the market is going up, but also when it is going down, or even sideways.  However, the strategies covered in this publication are targeted towards stocks and markets that trend up or down, not sideways.  When one enters a trade looking to profit if a stock (or market) goes up, one is said to be ‘going Long’.  Alternatively, if the expectation was that a stock was going to go down, one could aim to profit by ‘going Short’.

 Fundamental Analysis: Some traders try to determine whether a stock price will rise or fall in the future by analysing the company itself; who runs it, how well it does whatever it does, company reports, and the financial position (including profit and loss statements, balance sheets, etc).  Fundamental analysts will be very interested in the earnings, outgoings and environmental factors which influence a company, as well as data such as the; Earnings Per Share (EPS), PE Ratios, Return On Capital, (etc).  Fundamental analysts tend to operate from the view that a share price will return to its true value.  We tend to believe that the possibility exists for fundamental analysis to be misleading, particularly if a company uses more creative accounting strategies, such as; overestimating goodwill, failing to allow for replacement of plant and equipment, regular reporting of ‘abnormal expenses’, and so on.

 Technical Analysis: Technical analysts use charts which reflect actual price movements in the stock (or market) over a period of time.  By studying the movements in price, they look for trends or patterns that suggest the direction the stock or market will move, and make their decisions primarily on the basis of what the stock has actually been doing.  Technical analysts may use some aspects of fundamental analysis in their trading, for example, when company reports are expected to be released, and when dividends are due to be paid.

 We prefer technical analysis over fundamental analysis because charts and prices are statements of fact.  Also, with technical analysis, specific (mechanical) entry and exit points can be identified.