Trading terms and concepts to perfect before your next trade

Whether you’re just starting out or in need of a refresher, we’ve put together some of the most essential trading concepts and terms to help ensure you’ve got the basics covered.

Diversification

What is diversification?

Diversification is the act of spreading your available investment funds across a variety of different types of securities or products. The idea is to reduce the impact that any one poorly performing security or event could have on your portfolio, while helping you improve your long-term return potential, as different securities perform well at different times (like stocks and bonds).

How do I diversify?

There are a number of different ways to diversify your portfolio, depending on your comfort with risk and confidence in your investment knowledge. Stocks and bonds can both be purchased individually. And many people are comfortable with building their own portfolios of either. For example:

  • It can be wise to diversify your equities among different industries (like technology, automotive, and consumer stables) in order to reduce the risk that a problem in one industry will affect your whole portfolio.
  • It may also be wise to purchase stocks of different sized companies. Small companies have higher risks, for example, but are often able to rebound faster than their large counterparts.
  • Similarly, it may make sense to have different types of bonds with different maturities in your portfolio.

Another way to diversify is to purchase mutual funds and/or ETFs. With one trade, you can purchase portfolios diversified by sector, company size, region—or all of the above. Ultimately, it’s important to find the balance between building adequate risk management into your portfolio, and feeling comfortable with what you own.

Trading

What are the bid and ask?

Investment markets need both buyers and sellers—and these two need to agree on a price for a trade to happen. The bid is the price at which the buyer is willing to purchase the underlying asset, while the ask is the price at which the seller is willing to sell it. The difference between these two numbers is called the spread (see below).

What is the spread?

It would be impossible to display every single bid and ask price for a particular security, so the official bid for one particular security is considered the highest price that a buyer is willing to pay, and the official ask is considered the lowest price that a seller is willing to accept. The spread is the difference between the two. Typically, securities that trade frequently have smaller spreads due to their liquidity (the ability to buy or sell a security readily without affecting its price). For those that trade less frequently, the spread can be larger.

What is volume?

Volume is the total number of shares or contracts that are traded within a given time period for a particular security. Volume can be calculated for a wide range of assets, including stocks, bonds, options, and ETFs. Some assets can have a daily volume of zero, while common shares of large public companies can have a daily volume in the tens of millions. Trading in an asset with higher volume makes it much easier to buy or sell it quickly, due to their liquidity and the smaller spread.

What is a fill?

A fill is the act of completing a trade. It is when the buyer and the seller have found a mutually-agreeable price, and the underlying asset is transferred between the two parties.

What are the different order types?

More information about our order types can be found here.

Margin accounts

What is a margin account?

Simply put, margin accounts allow you to borrow funds from a broker to purchase securities, in addition to using your own money. The most common type of investment vehicle purchased with margin accounts are stocks; however, futures and options contracts may also be available, depending on the broker. The securities purchased with the loan are typically held as collateral by the broker, with the borrower accumulating interest until the loan is paid off, along with any applicable fees and commissions.

Why use a margin account?

Using a margin account in this manner allows you to increase the amount of money you invest, which enhances your potential profit. And while this is exciting, there are additional features that make the solution attractive, particularly to the more sophisticated investor. For example:

  • Under Canadian tax law, interest earned from money borrowed for the purposes of earning income is tax deductible. This could be especially appealing to those in a higher tax bracket.
  • Greater investing power makes margin an effective diversification tool for any portfolio.
What are the risks of a margin account?

Just as the rewards you can reap when investing with borrowed money are higher, losses can be felt more intensely as well. Additionally, with increased buying power comes increased costs, as you need to pay back your loan with interest even if the value of your investment decreases.

One other risk scenario to keep in mind is a margin call. If the value of the loan within the account falls below a certain amount (known as the maintenance margin), this could result in a margin call by the broker. In this scenario, the broker can request the investor deposit more money into the account, or sell securities to cover the difference. Different brokerages may have different maintenance margin requirements and may have the authority to sell investors’ holdings at their own discretion, adding to the uncertainty of using a margin account.

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