Glossary of terms
Capitalization otherwise known as ‘Market Cap” from a financial perspective, refers to the market value of the outstanding shares of a company that trades openly. At the same time, it can then serve as a measurement of the company’s net worth via the public eye. It can also then be used as a form of stock valuation for the company in question. A company’s size is important to investors as among st other characteristics it can also determine risks associated with buying shares of that particular company.
The market cap valuation is calculated by multiplying the outstanding shares with the current stock price, but this only refers to the equity value of the company. There are a number of other techniques that can be applied as a method of determining the market cap valuation; some of these include the theoretical approach as well as an estimation using comparable factors.
The investment community uses [market capitalization] to classify companies according to their size. Initially, companies were classified as small-cap, mid-cap, and large-cap. Subsequently, the terms have now expanded to also include micro-cap and mega-cap and in some instances also nano-cap.
Market experts suggest that the best approach for an investor is to hold a balanced and diverse portfolio of blended market caps as this will produce more favourable results and also provide the investor with valuable knowledge at the same time. However, by no means does a diversified portfolio serve as a shield to mitigate risk or curb potential losses.Key Takeaways:
- Capitalization is more commonly known as market cap and refers to the market value of the outstanding shares of a company that trades on the open market.
- This can serve as a calculation of the company’s net worth and can also indicate the possible risks associated when buying shares.
- Market cap is calculated by multiplying the outstanding shares with the current stock price.
- Small-cap, mid-cap, large-cap, micro-cap, mega-cap, and nano-cap are categories that market cap can be classified as.
- Best practice from industry experts is to have a diverse portfolio by mixing different market caps.
A capitalization-weighted index can also be referred to as a market-value-weighted index. This is a form of a [stock market index] whose different elements are weighted according to the total market value of the outstanding shares. In total there are about 3.3 million different stocks traded globally and many of these will be included in a weighted index.
The method for calculating the price-weighted average is to add the stock prices together and then divide this by the number of shares in the average. It’s an intricate and carefully balanced method in that if the [market-cap] rises and the stock price rises it will attain a bigger weighting in the index, however, a decrease in stock price and market cap will mean that the weighting in the index will drop.
An additional form of market-cap index is known as the free-float adjusted market-cap weighting. This method adjusts the market-cap index weights by the outstanding shares of each component company. These are the shares that are not readily available to the public on the open market and can be owned by institutions such as the government for example. Free float is a very sophisticated method and each different index will have its own method and therefore each one can produce a different result.Key Takeaways:
- A capitalization-weighted index can also be referred to as a market-value-weighted index.
- The method of calculating the price-weighted average is to add the stock prices together and then divide this by the number of shares in the average.
- Market-cap index has a limitation in that the investments are expensive in nature.
- Free-float adjusted market-cap weighting is a form of a market-cap index.
- There are various globally traded weighted indices such as S&P 500, Dow Jones Industrial, Nikkei 225, NASDAQ 100, FTSE 100, CAC 40 & DAX 50 to name just a few.
This is a currency trading strategy that benefits from the differentials between a currency offering a low borrowing interest rate and a currency offering a high lending interest rate. In essence, the trader will borrow/buy ‘low’ and lend/sell ‘high’.
Carry trades are some of the most manageable strategies and also the oldest available for currency trading. They are also very popular amongst foreign exchange traders due to the fact that traders are able to trade on margin and only a small deposit is required to exercise control over a large trade amount.
A carry trade is when a trader buys a high-interest currency or [instrument] against a low-interest currency or instrument. Or when a trader borrows a currency at a lower interest rate to obtain another currency that has a higher earning interest rate.
In forex exchange trading carry trades can be classified as either positive or negative. A positive carry trade refers to investing borrowed currency from a country offering a low interest rate and using this to buy a currency offering a higher interest rate. The trader will then profit in the differential between the two interest rates. A negative carry trade is the opposite in that the trader will borrow a currency with a higher rate of interest to buy a currency [yielding] a lower rate of interest. The trader will suffer an initial loss on a negative carry trade due to paying higher interest but they will take the trade if they are bullish (positive) regarding the lower interest rate currency’s appreciation aspects i.e they believe that the lower interest rate currency will appreciate versus the higher interest rate currency.Key Takeaways:
- Carry trades are a form of trading strategy.
- Carry trades are one of the simplest forms of trading and also the oldest.
- Traders use margin trading for carry trades because only a small amount of deposit is required to control a larger trade amount.
- There are two forms of carry trade, namely: Positive and Negative Carry.
Commodity currency refers to the types of currencies that move in parallel with the global economy prices of primary commodity products like raw materials and natural resources such as agricultural goods.
In the foreign exchange markets commodity currency refers to currencies such as the South African Rand and New Zealand Dollar to name just two and is more widespread in developing countries such as Tanzania or Papua New Guinea for example.
There are dual qualities attached to commodity currencies in that being bound to any type of good or commodity can either be advantageous or disadvantageous to the country’s currency. As the fluctuations in exports will naturally either appreciate or depreciate, the counties that have commodity currencies will be more hard-hit as they are tightly bound to only a few commodities.
The Peruvian Sol, Columbian Peso, the Russian Ruble and the Canadian and Australian Dollar are all currencies that would be impacted by fluctuations in commodity prices.
One of the key features that make investing in commodity currencies so appealing to foreign exchange traders is that they are able to provide a more accurate estimate on the value of the currency and are also able to predict the movements within the markets based on the value of the underlying commodity.Key Takeaways:
- Commodity currency refers to a type of currency that co-moves with the global economy prices of primary commodity products.
- Currencies of countries like South Africa, Tanzania and Brazil are tied to commodity products.
- There are pros and cons attached to commodity currencies and this will depend on the price fluctuations in exports.
- Foreign exchange traders enjoy trading commodity currencies as they are able to provide accurate value estimates and can easily predict market movements in the currencies by looking at the value of the commodities.
Contracts for Difference, otherwise known as CFD’s commonly refer to an agreement between two parties that permits them to trade on the price movements of various different financial instruments.
This is an advanced trading strategy that is used by expert traders, however an interesting fact worth mentioning is that this trading style is not permitted in the United States of America.
CFD’s are a well-favoured method of derivative trading and allows the trader to speculate on the rising or falling prices of fast-moving global financial markets (or instruments) such as stocks, indices, equities, and foreign exchange. One of the key benefits of this form of trading is that the trader is able to trade on margin and can sell if they suspect that prices will go down or buy if they suspect that prices are on the rise. There are fewer regulations and requirements within the CFD market compared to other standard exchanges.
This means that there are lesser capital requirements involved for a brokerage account and a trader can often open a CFD trading account with as little as $1000 and trade to values of up to 10 times this amount by utilising the leverage available through the margin trading offered by many brokerages.
One of the biggest advantages of the CFD market for traders is that it easily allows the trader to take a long or short position. As the underlying asset or instrument is not physically settled there are no restrictions on short selling and no borrowing or shorting costs are incurred. Brokerage fees are often nil or extremely low as the brokers will earn their money through adding a [spread].Key Takeaways:
- CFD’s are cash-disbursed or cash-settled but uses satisfactory margin trading so that investors only need to put up a small amount of the contracts’ notional payoff.
- Contracts for Difference permits investors to trade in the direction of financial instruments over a very short-term period and is very popular with Forex trading (FX).
- The CFD pays the differences in the settlement amount between the open and closing prices of the trade.
The counter currency, otherwise known as the quote currency, is the second currency listed within a currency pair.
A slash (/) is used to indicate the respective values between the [base] and the counter currency, for example, GBP (base) / USD (counter). Together the pair makes up what is referenced as the quotation, GBP/USD. In the majority of the cases, the minor currency will form the counter currency.
The quotation then determines the amount of the counter currency which is needed to buy one unit of the base currency. One is essentially both buying and selling at the same time. For example, if the quotation for GBP/USD was 1.28, this would mean that it costs 1.28 USD to buy 1.00 GBP.Pairs are written using ISO currency codes; the Euro becomes EUR, the Great British Pound becomes GBP, and the US Dollar becomes the USD and so on. There are over 200 currencies available to be traded, so making yourself familiar with these ISO codes is important.
When a trader buys a currency pair, they are selling the counter currency and if they are selling a currency pair, they are buying the counter currency.
The unit of measurement to determine the change in value between the base and the counter currency is referred to as a [Pip].Key Takeaways
- Counter Currency is also known as the quote currency.
- Counter currency is the second currency that is listed in a currency pair.
- The counter, or quote, currency determines how many units of that currency are needed to buy one unit of the base currency.
- A Pip is the unit of measurement used to determine the change in value between the base and the counter currencies.
- The value of a currency is determined by the selling and buying price as a commodity.
Currency Correlation refers to the relationship between two different currency pairs. A positive correlation means that the currency pairs move together in sync, whereas a negative correlation implies that the currency pairs each move in a different direction, away from each other.
If a relatively new trader intends to trade more than one currency pair at a time, it is important to have a firm grasp on how the different currency pairs move in relation to one another.
Correlation between the currency pairs is determined by what is known as the currency correlation coefficient and this ranges between -1 and +1. A coefficient of +1 will imply that the pairs move identically in the same direction 100% of the time and conversely a coefficient of -1 will imply that they move in different directions 100% of the time. Obviously values within this range will imply different levels of movement between the related pairs.
Perfect positive correlation is when the pairs have a correlation coefficient of +1 and a perfect negative correlation implies that the pairs have a correlation coefficient of -1.
Where the correlation coefficient in zero this implies that the movement of the currency pairs is totally random and not related to each other.
GBP/USD, AUD/USD, and EUR/USD are three of the most traded currency pairs on the foreign exchange markets. They are all in positive correlation with one another due to USD being the counter currency in the pair. Any changes in the exchange rate of the USD will impact the pair in its entirety.Key Takeaways:
- Currency Correlation refers to the relations between two different currency pairs.
- There are two types of currency correlation, namely, positive and negative.
- Coefficient is the correlation between the two currency pairs.
- Perfect positive correlation has a coefficient of +1 and perfect negative correlation has a coefficient of -1.
If the correlation is 0, it implies that they are random and move independently from one another.