Stock Term – Arbitrage

Arbitrage technically means a riskless play, but since I’m not a market maker I am normally talking about merger arbitrage.  When two companies merge or get bought out there’s usually some cash value placed on the target company stock, a ratio of the acquiring company shares that the target company will receive, or a combination of both.  For example, company A may buy company B in a deal where company A will give $1.00 plus 0.5 shares of company A for every share of company B stock.  Usually there’s a spread where you can go long on one stock and short the other stock in the correct ratio such that you will make money regardless of whether the stocks move up or down.  To compute the ratio just calculate the value of one of the stocks in terms of the other stock.  In our example you would take $1.00 + (current A share price * 0.5) to compute the value of a B share. 

Once you make the purchase your profit is locked in, even if the spread increases or decreases, since your B shares will be converted to a fixed amount of cash or will just cover the short A shares in the end.  Also, don’t forget to take into account any dividends since you’ll be out money on the short shares or gain extra money on the long shares.  The reason this spread exists is because there’s always the chance that the deal will fall through, like if they fail to pass some federal regulations or if one company just gets cold feet.  Normally there aren’t many profitable opportunities with this type of play for the common investor, but it’s good to know about anyway since at some point you’ll be holding a company that gets bought out.

Stock Term – Breakout

Breakouts are simply price moves above or below a level of support or resistance.  I’ll usually call a breakout that falls through resistance a “breakdown” for clarity.  I’ll also tend to call things “breakouts” only if they’re supplemented with significantly higher than average volume.  These are the things that kick off new trends, so needless to say they’re important to watch for.

Stock Term – Consolidation

This is an overloaded term in the stock world, but on this site I will typically use it in the sense of technical analysis. Consolidation is a period of sideways movement in a stock, also known as a base. During this phase, there are generally distinct levels of support and resistance which create a defined trading range. The longer this lasts, the better it is for trading a breakout, since there will be stronger support at that level.

Stock Term – Extended

The amount a stock is extended is simply how far it is beyond its buy point.  You normally want to buy a stock that’s at least a tick beyond its buy point, but if a stock goes too far beyond that it gets overextended.  The reason this is important is because all smart traders and investors set loss limits for themselves, and the first level of resistance will usually be where the initial breakout level was.  The further a stock is extended, the further the resistance is, and the further your sell point will be, making more risk.  When trading breakouts, I like to enter when the stock is about 1% to 5% beyond the breakout price, since that allows a stop of 5% to 10%.  In my opinion, anything beyond that is considered overextended, and the smart move would be to wait for a pull back and bounce off the original breakout price before buying, even though you’ll find that it sometimes means you’ll miss a move. 

Stock Term – Fade

Fading something means going against the trend.  For example, "fading the gap" means trading against the direction of a gap, i.e. if a stock gaps downwards fading it would mean purchasing shares long, and if a stock gaps upwards fading it would mean selling shares short.  This site will never recommend fade plays since I always trade with the trend.  Don’t confuse swing trades off of support/resistance with fades, since in that case you are still trading with the longer term trend, but just looking for overselling/overbuying in the shorter term time frames.

Stock Term – Fundamental Analysis

Fundamental analysis is using financial statements, i.e. income statements, cash flow statements, and balance sheets to aid in your stock purchasing decisions.  These statements define a company’s financial health and are important for determining their intrinsic value.  Since I like growth stocks and take a lot of my techniques from William O’Neil, the fundamental numbers I mainly look at are the earnings and ownership (both insider and institutional).  Of course revenue, cash, debt, etc. are all important too, but most of my screens start with earnings.  When I say a company has good numbers, it usually means that the earnings are good and all of the other fundamental numbers meet or exceed my expectations.

Stock Term – Short Squeeze

A short squeeze occurs when people holding short positions are forced to cover usually due to margin requirements, causing a stock to shoot up, which causes even more people to cover and strengthens the upwards move.  This is usually seen in stocks that are down a lot, and is often times the cause for large unexplained bounces in bad stocks.  I don’t normally like to trade the squeeze since I don’t like going against the general trend, but if it clears out enough of the shorts it is often times a good place to swing trade when it starts heading south again.

Stock Term – Slippage

Slippage is the difference between the amount you want to buy a stock (or anything else) for and the amount that you actually get it for.  When you’re trading a breakout, the slippage can be pretty large since the market will move very quickly while the breakout is occurring.  This is one of the reasons paper trading is different than real trading, since you can’t simulate the slippage on a paper trade.  It’s also a good reason to avoid nanocap stocks or anything else that lacks liquidity (like after hours trading), since the bid/ask spread will be larger, and you’ll pay more than expected on the entry and get less than expected on the exit.  If you’re new, it’s just one of those things you’ll have to experience a few times to understand.

Stock Term – Stop Out

I use the term "stop out" to generically mean selling when a stock goes below my sell point.  I don’t always use actual stop orders, but when I don’t, it just means I’m manually selling the stock when it hits my predetermined sell point.  If you find yourself getting wishy washy once the stock actually gets around your sell point, you should probably put in a stop order to force the trade execution. 

Stock Term – VIX

According to Wikipedia:

VIX is the ticker symbol for the Chicago Board Options Exchange Volatility Index, a popular measure of the implied volatility of S&P 500 index options. A high value corresponds to a more volatile market and therefore more costly options, which can be used to defray risk from volatility.

The VIX can be used for a lot of things, but I usually use it as a complementary indicator to volume.  A declining VIX often means a consolidation period, and an increasing VIX often means an accumulation or distribution period.  You can find the chart for it here, but it’s available on pretty much every stock site.

Stock Term – Whipsaw

A whipsaw is when a stock does the opposite of what is expected.  Often times this means the stock hit support or resistance and either broke through or started to turn, but then whipped back the other direction.   Since everyone uses different indicators and has different levels of skill, one person may get whipsawed while the other person makes money hand over fist.  If you find yourself getting whipsawed often, you should probably consider changing strategies or increasing your filters, since you’re probably trying to trade in those borderline regions too much.