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Making sense of stock market terms
You don’t need to be an economist to start investing. But knowing some key terms will help you better understand what’s happening in the stock market and how it's effecting your investments.
Stock market indices
When people report on “the market,” they’re actually referring to a subset of the market represented by a market index that tracks a smaller group of stocks. There are three that you’ll often hear about in this context:
Most times when you hear the market is down a certain number of points, it’s usually a reference to the Dow Jones (aka “the Dow”). However, it really isn’t the best way to measure the overall market because the Dow only represents 30 of the largest companies in the United States.
The S&P 500 is a better indicator of the overall market because it represents 500 stocks in the US. And since it includes a more diverse group of companies, it provides a broader perspective of the overall market’s performance.
The NASDAQ index represents every stock traded on the NASDAQ exchange. And while it’s the second-largest stock exchange in the United States, it certainly has the longest name: “National Association of Securities Dealers Automated Quotations System.”
Basic economics & stock market terms
While the market indices are used to approximate the market’s performance, they’re often paired with commentary about why some person or news source thinks the market is doing what it is. Here are some of the factors you’ll hear referenced because they can have a significant impact on the markets as a whole:
Gross Domestic Product (GDP)
This is the total value of all of the goods and services produced by a country. It’s commonly used to determine the health of an economy. So when GDP goes up, it generally indicates the economy is doing well.
Inflation happens when the overall price of goods and services goes up. Some inflation is good, because it indicates that the economy is growing. But too much inflation too quickly can devalue money.
Consumer Price Index (CPI)
The consumer price index is the price of a standard basket of goods and services most people have to buy most of the time — like food and electricity. It’s used as a key measure of inflation. When the CPI goes up, it means prices are rising overall and inflation is happening.
When more people are employed, the economy is assumed to be doing better and vice versa. That’s why unemployment is often used as a measure of the overall health of the economy. When unemployment goes down, it’s a good sign. And when it goes up like it has in 2020, it’s a bad sign.
Consumer confidence is about feelings. Specifically, how people feel about the economy as a whole and whether they think it’ll do well in the future. When consumer confidence is high, it indicates people feel positively about the future of the economy. And are likely to spend more as a result.
Stock market influencers
Finally, there are some decision-makers who are big enough and influential enough that they can directly impact the economy as a whole. While consumers can collectively influence the economy, our individual decisions aren’t usually news. That’s not the case for one key market player:
Federal Open Market Committee (The Fed)
The Fed is a government body responsible for influencing monetary policy by controlling the interest rates in the country.
If the economy is growing too quickly — and at risk of inflation — they’ll raise their target interest rate. This makes it more expensive to borrow money and discourages lending. On the other hand, if the economy’s growing too slowly, they’ll lower the interest rate to make it cheaper to borrow money. The goal being to stimulate the economy and help it grow.
Ready to walk the talk?
You now have a solid foundation of the key terms and players that impact the economy. And that’s really all an everyday investor needs to understand, especially since trying to predict what the market and the economy will do in the future is nearly impossible. That said, investing doesn’t have to be scary and intimidating. In fact, it’s one of the most powerful ways to reach your goals and build wealth over the long term.