Before investing, you need to understand what is displayed on your screen. Stock market jargon looks intimidating, but the essentials come down to a handful of notions. Mastering them spares you costly mistakes, such as paying far more than planned simply because you had not grasped what a number meant.
Price, order book and spread
The price is the last price at which a security was traded. It changes constantly during trading hours, then freezes at the close. It is not a guaranteed price: by the time you place an order, the price you actually get may differ slightly from the one you saw. Securities are quoted in a specific currency and on a specific trading venue, two things to check before buying. Market capitalisation, for its part, measures the size of a company: the price multiplied by the number of shares outstanding. A €10 price says nothing about a company's value, because everything depends on the number of shares issued. Comparing two companies on their price alone therefore makes no sense. Each security has an order book where offers are lined up. The best price someone is willing to pay is called the bid, the best price someone is willing to sell at is the ask. The gap between the two is the spread: an implicit cost you pay on every round trip, on top of any brokerage fees.
Worked illustration (fictional)
A security shows a bid of €49.90 and an ask of €50.10. The spread is €0.20, or 0.4% of the price. If you buy at €50.10 and immediately sell at €49.90, you lose €0.20 per share without the market having moved. On 100 shares, that is €20. These figures are purely illustrative.
Liquidity
Liquidity is how easily an asset can be bought or sold without moving its price. A large, heavily traded stock has a tiny spread and trades in seconds. A small, thinly followed stock has a wide spread, and a large sale can push the price down on its own. Liquidity is judged by daily trading volume and the tightness of the spread. Finally, remember the difference between a security and an index. A security is a specific instrument (a share, a bond). An index, such as the S&P 500, is a statistical basket that measures the trend of a market: you cannot buy it directly, but exchange-traded funds (ETFs) replicate it.
Beware of small caps
A 2% or 3% spread on an illiquid stock means you start every investment with an equivalent loss. Check the volume and the bid/ask gap before placing an order, especially a market order.
Key takeaway
- ✓The price is a moving figure, not a value: only market capitalisation lets you compare the size of two companies.
- ✓The spread is a real cost on every transaction, and the higher the less liquid the security is.
- ✓Check the trading venue, the currency and the volume before any order.