Want to learn how to trade? Trading in financial markets can be an exciting and potentially lucrative endeavor.

For beginners, the trading world is often a confusing place filled with jargon and concepts that can feel like a maze at times. A solid understanding of key trading terms will give you a great foundation.

In this article, we take a look at the top 10 trading terms you should know, backed up with examples and real-world scenarios to help you get a grasp on the fundamentals of how to trade.

How to Trade: Understanding the Basics

 Before going into the specific terms, it is important to understand the concept of trading. It is the process of buying and selling a financial instrument with the hope of making a profit.

Traders analyze trends, economic factors, and other indicators to make informed decisions about trading.

Here are the top 10 trading terms you need to understand:

1. Market Order

 A market order is an order to buy or sell a financial instrument as soon as possible at the best price available at the time. The market order is the simplest and most common way to execute a trade. If you wanted to buy shares of the company Apple Inc. and the current market price for the shares was $150, a market order to buy those shares would cause your purchase to occur at or close to that price.

Real-Life Application

 Suppose you’re watching TV and hear that a tech company just rolled out an amazing new product and you expect that the stock price will rise, so you enter a market order to buy shares right away so that you can benefit from the price increase.

2. Limit Order

 A limit order is an order to buy or sell a financial instrument at a specific maximum or minimum price, rather than at whatever price is the current best offer (market order). 

For instance, I might put a limit order to buying shares of Amazon but only if the price falls to $3,000. If the price rises to my demand, then not only will the shares not be purchased, but I’ll miss out on the opportunity to buy them as well.

Real-Life Application

Suppose that you’ve been watching a stock that is trading today at $100, and want to buy it at $90. 

You put in a limit order at $90 and if the price comes down to $90, your trade will be filled.

3. Stop-Loss Order

A stop-loss order is an order to sell a position at a specified price to limit an investor’s loss of the position. For instance, if you own a stock currently worth $50 and you wish to limit your loss on the stock to 10%, you would place a stop-loss order at $45.

Real-Life Application

 Suppose you have bought a highly volatile stock. you put an order in place to sell your position automatically if the price of the stock were to fall 10% below the price at which you bought it, known as a stop-loss order.

4. Bid and Ask Price

The bid price is the highest price that a buyer is willing to pay for an instrument, and the ask price is the lowest price a seller is willing to accept. 

The difference between the bid and ask prices is the bid-ask spread. 

For example, if a stock’s bid price is $100 and the ask price is $102, this spread is $2.

Real-Life Application

When you’re ready to buy a stock, you’ll see both the bid and ask price. If the asking price is within your budget, you would place a market order to buy the stock at that price. 

On the other hand, if you were selling, you’d look at the bid to determine if it’s within your expectations.

5. Leverage

 Leverage is borrowing to increase the potential profit from an investment: trading on margin. It lets you control a bigger position with a smaller amount of capital. With 2:1 leverage, an investor can control an asset worth $20,000 with just $10,000.

Real-Life Application

 Say you have $5,000 to trade forex. If you use 10:1 leverage, you can control a $50,000 position. This can magnify potential profits, but also amplify the risks of substantial losses.

 How to Trade: More Essential Terms

Learning these extra words will only add to your trading jargon and you will be a lot more comfortable with the how-to-trade lingo.

6. Margin

The margin is the amount of money a trader must deposit with a broker in order to initiate and maintain a leveraged position. 

The margin is meant to cover losses incurred on the position. For example, if your broker requires a 10% margin, you’ll need to put up $1,000 in order to take a $10,000 position.

Real-Life Application

For example, if you wanted to buy or sell futures contracts, but didn’t have the full value of the contract at your disposal, the margin allows you to enter the trade with a fraction of the total contract value, as long as you maintain the required margin level.

7. Volatility

 Volatility is a measure of the degree to which the price of a financial instrument moves over a particular period, and it is defined as the standard deviation of the logarithm of daily returns. 

Therefore, the higher the volatility, the bigger the price swings are, and vice versa: the lower the volatility, the less the price changes. For instance, tech stocks usually display higher volatility than utility stocks.

Real-Life Application

 If you are a trader of options, you might prefer stocks with high volatility, because they offer greater profit opportunities from price movements. If you prefer low volatility, stocks with lower volatility might be your preference.

8. Bull and Bear Markets

 When prices of financial instruments – such as shares, bonds or derivatives – rise, or are expected to rise by at least 20%, this is known as a bull market. When prices fall, or are expected to fall by at least 20%, it’s called a bear market. 

The US stock market had a bull market in the 1990s. The 2008 financial crisis was followed by a bear market.

Real-Life Application

 Knowing whether you are in the midst of a bull or a bear market could determine your trading strategy. If you are in a bull market, you might be tempted to buy stocks, as their price is likely to rise. If you are in a bear market, consider short-selling or investing in defensive assets.

9. Short Selling

 With short selling, you sell a financial instrument you don’t own, in the hope of buying it back for less. Traders make a profit if the price falls. For example, if you’ve short-sold a stock at $100, and it falls to $80, you can buy it back for the lower price and pocket the difference.

Real-Life Application

 In a bear market, you can attempt to spot overvalued stocks that are likely to fall in price. Then you can short-sell these stocks and pocket any profits as their prices plummet.

10. Diversification

 Diversification is a risk-mitigation strategy where, by investing in multiple assets, the investor lowers exposure to any single asset or risk. A diversified portfolio might consist of stocks, bonds, real estate, and commodities.

Real-Life Application

 You might invest in various sectors and asset classes to diversify your portfolio and reduce your overall risk to market volatility—that is, poor performance in one area is offset by better performance in another.

 How to Trade: Putting It All Together

 Now that you’re familiar with the top 10 trading terms, let’s discuss how to trade by using this knowledge. 

Developing a Trading Plan

 A trading plan is your route map to success. It defines your objectives, your risk tolerance, and your rules for entering and exiting trades. It all starts with identifying what you want to achieve by trading. Are you looking for quick profits or long-term growth?

Analyzing the Market

 Traders who make money use different techniques to make their decisions. One is technical analysis, where a chart of prices and indicators is studied to look for patterns and try to make an educated guess as to where the market is headed. Fundamental analysis tries to understand the health of a company and the industry it operates in, as well as broader economic conditions. 

The two can be combined.

Managing Risk

 Risk management is about setting limits to your trades. Never risk more than you can afford to lose. Minimize potential losses with stop-loss orders, and diversify your portfolio to spread risk exposure. Leverage can boost gains and losses, so use it with caution.

Keeping Emotions in Check

Trading can be emotional; fear and greed can both cloud your judgment. Stay with your trading plan, and trade it consistently. Be disciplined and stay objective to increase your chances of success. 

How to Trade: Continuous Learning

 Markets are dynamic – traders who make money are always learning. Keep up with market news, listen to webinars, read books, and get involved in trading communities. The more you learn, the better you’ll be at trading. 

Learning how to trade requires patience, persistence, discipline, and constant learning. Once you understand and apply these 10 trading terms, you’ll have laid a solid foundation for your trading career, increasing your confidence in the market. 

Whether short-term trading or long-term investing, these principles will help you become a more knowledgeable and successful trader.