Key Terms for Tough Times: The Vocabulary of Stressed Markets
When financial markets experience turbulence, Wall Street employs a jargon all its own to describe important elements of uncertain times. Here's a look at some of the most common terms and what they mean.
Bear Market: When a stock or bond index, or a commodity's price, falls and keeps falling, it’s considered to be in a bear market. Generally, a decline of 20 percent or more in a broad market index is said to meet the threshold of a bear market. The term is often used in contrast with "bull market," which refers to a large increase in prices.
Bubble: When prices—whether for stocks, housing or another asset—rise to levels that appear inexplicably high, it's known as a bubble. Inevitably, a bubble pops and prices fall.
Correction: A correction is when stocks, bonds, commodities or indices reverse course by at least 10 percent before resuming their previous upward or downward trend. Though a correction can technically describe either a 10 percent increase or decrease, usually it's used in reference to a drop in prices.
Dead Cat Bounce: A dead cat bounce refers to the temporary spike in the price of a stock after a major decline.
Hedge: Hedging refers to the act of making investments intended to offset possible losses—in other words, to mitigate risk. If, for instance, a shareholder in Company X is concerned that its share price might fall, they might hedge by buying a put option—a contract that allows an investor to sell a certain number of shares in the company at a certain price by a set date. The option can help the investor avoid at least some losses if the company's share price does decline.
Limit Up/Limit Down: Limit up/limit down, often called LULD, are regulatory requirements designed to address extraordinary market volatility by ensuring that stocks don't trade outside of particular price parameters. LULD works by establishing a highest and lowest permissible price for each stock trade. The price parameters are determined by allowing a certain percentage leeway above and below a set reference price. The reference price generally is the average of the price of the trades that took place within the last five minutes (on a rolling basis).
Liquidity: Markets are said to have liquidity when participants are able to quickly buy and sell securities without significantly affecting their prices. Liquidity declines when it becomes more difficult to trade an investment due to an imbalance in the number of buyers and sellers, or because of price volatility. A security that can’t be bought or sold without a major change in price, or where it’s difficult to find a counterparty to buy or sell, might be described as illiquid.
Margin Call: Some investors might use a margin account, which can allow them to borrow money from their brokerage firm to purchase securities. These investor loans are collateralized by either the securities they've purchased or by cash. But if the prices of the securities fall by more than a certain amount, which can happen in bear markets or during corrections, firms might issue a margin call requiring customers to deposit additional cash or securities as collateral for their loans. If the investor fails to meet the margin call requirements, the firm can force the sale of those securities or other securities in the investor’s account—sometimes without notice.
Market-Wide Circuit Breaker: When the general stock market drops precipitously, a market-wide circuit breaker might be triggered. Specifically, if the S&P 500 falls either 7 percent (a Level 1 halt) or 13 percent (a Level 2 halt) from its closing price the previous day before 3:25 p.m., trading is shut down across all stock and futures exchanges for 15 minutes. A drop of that size after 3:25 p.m. wouldn’t trigger a Level 1 or 2 halt. If the S&P 500 drops 20 percent (a Level 3 halt) or more from its previous closing price at any time during the trading day, trading shuts down for the rest of the day.
Overbought/Oversold: When the price of a stock or many stocks in a market jumps, someone who believes that it’s due for a correction might say that the stock or the market is "overbought." When the price of a stock or many stocks in a market decline steeply and suddenly, some might speculate that the stock or the market is due for a rebound and say it’s "oversold."
Panic Selling: When investors fear that a security or market is facing a rapid price decline, they might offload large amounts of shares without necessarily doing thoughtful analysis to determine whether selling is the wisest move. When investors engage in panic selling, the result might be a self-fulfilling prophecy: The widespread sale of a stock does usually lead to a decline in price.
Risk-On/Risk-Off: Certain assets are considered to carry more risk than others. During periods of market turmoil, some investors might adopt a "risk-off" strategy, meaning they sell their riskier assets to buy less risky ones. Alternatively, when investors feel the market and its outlook are strong, they might buy riskier assets while selling less risky ones, creating a risk-on environment.
Safe Haven: Investments are described as safe havens when it's commonly believed they won't lose value in the face of market turmoil. The types of investments that are considered safe havens can vary over time, and sometimes experts disagree as to whether a certain investment should be considered a safe haven. Ultimately, it's important to remember that no investment is guaranteed to be "safe."
Sell-Off: A sell-off describes what happens when, following a major decline in the prices of stocks, bonds or other securities, market participants collectively sell large quantities of those falling securities as they seek to prevent losses from future price declines.
Volatility: When a security, a commodity or an index fluctuates wildly in a short period of time, it’s experiencing volatility. Certain indices, such as the Chicago Board Options Exchange's Volatility Index (VIX), measure the expected volatility of U.S. stocks by gauging investors' expectations of major market moves. Financial market regulations include certain buffers (e.g., LULD price bands) to curb volatility.
