[Update 3.28.2017] Key Terms for Tough Times: The Vocabulary of Stressed Markets
The second half of March has not been kind to the Dow Jones Industrial Average. The index, which tracks 30 U.S. blue-chip companies, closed down on Monday in its eighth consecutive drop—marking the longest streak of declines for the index since 2011.
The long streak of declines, which wiped away 1.9 percent of the Dow’s value, was blamed on political developments, namely the recent demise of efforts to repeal the Affordable Care Act. (Learn more about the significance of political risk and other types of risk for financial markets here.) A report showing an increase in consumer confidence, however, sparked a turnaround Tuesday, with the Dow regaining 0.7 percent.
The volatility in stocks has prompted the re-emergence of jargon often used to describe important elements of financial market turbulence, such as correction and risk-off.
Here’s a look at these, and some other common terms, that make up the vocabulary of stressed markets.
Bear market: When a stock or bond index, or a commodity’s price falls and keeps falling, it is considered to in a bear market. Often a decline of 20 percent or more in a stock 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. The longest bear market in U.S. history occurred during the Great Depression, during which time the Dow Industrial Average fell for four consecutive years.
Bubble: When prices—be they stock, housing or other asset prices—rise to levels that appear inexplicably high, that’s known as a bubble. Inevitably, a bubble pops and prices fall down to earth. Perhaps the most infamous bubble in recent U.S. history was the real estate bubble that played a major role in the 2008 financial crisis.
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 a 10 percent bump or drop, usually it’s used in reference to the latter. In August 2015, a number of indices saw corrections, including the S&P 500, which dropped from about 2,100 to below 1,870 in less than two weeks before trending upward again.
Dead cat bounce: Perhaps the most grisly term in Wall Street’s lexicon, a dead cat bounce refers to the temporary spike in the price of a stock after a major decline. The phrase originates “from the facetious notion that even a dead cat would bounce slightly if dropped from a sufficient height,” according to Merriam-Webster.
Hedge: In investing, to hedge 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, he may hedge by buying what’s known as 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 would help the investor avoid at least some losses if Company X’s share price does, in fact, decline.
Liquidity: Markets are said to have liquidity when their participants are able to quickly buy and sell securities without significantly affecting the prices of those securities. 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, according to a recent FINRA Investor Alert. A security that cannot be bought or sold without a major change in price may be described as illiquid.
Margin call: Some investors might use a margin account, which can allow investors to borrow money from a broker 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—brokers may issue a margin call requiring clients to deposit additional cash or securities as collateral for their loans. If you fail to meet the margin call requirements, the firm can force the sale of those securities or other securities in your account—sometimes without notice.
Overbought/oversold: When the price of a stock jumps, someone who believes that it is due for a correction might argue that the stock is “overbought.” When a stock or many stocks in a market decline steeply and suddenly, some might speculate that stock or the market is due for a rebound. When making such a prediction, one would say the stock or market is “oversold.”
Panic selling: When investors suddenly conclude that a security or market is doomed to a rapid price decline, they might engage in panic selling, offloading massive amounts of shares without necessarily doing thoughtful analysis to determine whether selling is the wisest move. When investors engage in panic selling, the result may be a self-fulfilling prophecy: The widespread sale of a stock does usually lead to a decline in price. Panic selling is often associated with market crashes, notably the crash that kicked off The Great Depression in 1929, and 1987’s infamous one-day crash known as Black Monday.
Risk-on/risk-off: In investing, certain assets, such as stocks, are considered to carry more risk than others, such as gold. During periods of market turmoil, some investors may adopt a “risk off” strategy, meaning they sell their riskier assets to buy less risky ones. Under a “risk on” strategy, the converse is true: investors buy riskier assets while selling less risky ones. During the 2008 financial crisis, the Wall Street Journal reported, “whole swaths of markets moved in unison, as “risk on” and “risk off” trades dominated.”
Safe haven: The term safe haven may make grammarians cringe—a haven, after all, is by definition a safe place, and so “safe haven” is redundant—but that hasn’t stopped brokers and investors from employing the term, especially when markets go south. Investments are described as safe havens when it’s commonly believed they won’t lose value in the face of market turmoil, or, in other words, the investments some might turn to when pursuing a “risk off” strategy. Exactly what types of securities and other investments are considered as safe havens can vary over time—past examples have included U.S. Treasury bonds, the Japanese yen and gold. But sometimes experts disagree as to whether a certain investment should be considered a safe haven or not. Ultimately, it’s important for investors to remember that no investment is guaranteed to be “safe.”
Sell-off: On Wall Street, when the going gets tough, many start selling. A sell-off describes what happens when, following a major decline in the prices of stocks, bonds, or other securities, market participants collectively sell massive quantities of those falling securities as each participant seeks to prevent losses from future price declines.
Volatility: When a security, a commodity or an index fluctuates wildly in a short period of time, they’re experiencing volatility. The Chicago Board Options Exchange’s Volatility Index (VIX) measures the expected volatility of U.S. stocks by gauging investors’ expectations of major market moves. The VIX reached a six-year intraday high during a historic period of volatility in the late summer of 2015, when on Aug. 24, the Dow Jones Industrial Average plummeted more than 1,000 points shortly after the open of trading before trimming back losses to 588 points by the end of the trading day. Financial market regulations include certain buffers to limit volatility. To learn more, see The Alert Investor’s “Guardrails for Market Volatility.”