Investing vocabulary is the language of opportunity. Understanding it helps you remain calm and rational while others panic. Still, when stock markets plummet, financial news becomes a whirlwind of unfamiliar terms.
Even seasoned investors can be puzzled by the jargon that suddenly dominates headlines. However, understanding this vocabulary isn’t just about decoding the news; it’s crucial for making informed decisions—for simply knowing what is going on—during turbulent markets.
These periods of widespread selling can be triggered by releases of new economic data, geopolitical events, or a panic years in the making without a precipitating event. For long-term investors, sell-offs can present both challenges and prospects. While seeing your portfolio value drop is stressful, these dips often create opportunities to invest in quality companies at a discount.
Below, we provide a cheat sheet for terms like “volatility,” “correction,” and “capitulation,” which are often heard during sell-offs. By understanding these concepts, you’ll be better able to interpret market shifts and keep calm during moments of market disruption.
Key Takeaways
- Stock sell-offs are a common element of the market, even if they are tough for long-term buy-and-hold investors to swallow.
- Sell-offs also conjure up a special vocabulary of finance and investing words in the media that may be unfamiliar, such as volatility, buying the dips, and short selling.
- Knowing the language of financial markets can only make you a better investor.
- Sell-offs are stress tests for your investment strategy. Knowing the terminology helps you navigate these periods with greater confidence.
1. Bear Market
A bear market occurs when a broad market index falls 20% or more from recent highs and remains there for at least two months. This prolonged decline often signals a loss of investor confidence and can be triggered by economic downturns, geopolitical crises, or bursting asset bubbles.
For example, during the 2008 financial crisis, the S&P 500 entered a bear market, falling almost 57% from its October 2007 peak to its March 2009 low. Bear markets can last for months or even years, testing the resolve of long-term investors.
2. Bond Yields
Rising bond yields are often blamed for a sell-off in stocks. As the Federal Reserve raises overnight lending rates and the yield, or return, on U.S. Treasury bond prices rises, bonds become more attractive to investors looking for a safer and less volatile place to put their money than stocks. In addition, higher yields can signal expectations of rising interest rates or inflation.
For example, if a 10-year Treasury bond yield rises from 2% to 3%, it might prompt some investors to shift funds from riskier stocks to the relative safety of government bonds. This shift can contribute to downward pressure on stock prices.
For much of the 2000s, bond yields were relatively low, but as they crept higher after the pandemic, this drew more money to them and away from stocks. The chart below shows the shift in two significant types of bond yields in the past couple of decades.
3. Buy the Dips
“Buy the dips” is trader slang for buying securities following a decline in prices, with the inkling that they have fallen for no apparent reason and should recover and keep rising in short order. It’s kind of like an unexpected sale at your favorite retailer, except what you’re buying on sale is expected to become more, not less, valuable over time. This doesn’t always work out in the stock market, but people often say this phrase with a confidence that suggests it does.
4. Capitulation
The term “capitulation” probably makes you think of a party giving up in a match or battle. But in investing, it’s another way of saying that you can no longer bear the losses in a particular security or market, and you’re going to cut your losses and sell.
When markets or a particular stock sell-off in heavy volume, many investors are tempted to abandon ship and sell their stakes as well or capitulate. That only exacerbates the losses. As such, when you capitulate, you’re hoping others can hold out longer than you.
5. Circuit Breaker
A circuit breaker is like the breaker box in your basement. However, this one shuts off the juice at the major securities exchanges. According to rules put in place over the last two decades, the New York Stock Exchange and Nasdaq are sometimes compelled to flip the switch when there is too much of an imbalance between sell and buy orders. The chart below uses a hypothetical example to show how it works:
6. Contagion
Contagion refers to the spread of market disturbances from one region or sector to others. During a sell-off, contagion describes how financial turmoil in one area can quickly spread, causing declines across various markets or asset classes.
For example, during the 2008 financial crisis, problems in the U.S. subprime mortgage market spread to the broader financial sector, then to the general economy, and ultimately to global markets. This domino effect is the hallmark of a financial contagion.
Contagion can occur for several reasons:
- Interconnected financial institutions
- Correlated investment positions
- Panic selling across markets
- Global trade and economic links
During market sell-offs, investors often worry about contagion, asking questions like “Will problems in tech stocks spread to other sectors?” or “Could a crisis in emerging markets impact developed economies?”
7. Correction
A correction is a 10% drop in the price of a security, market, or index from its most recent high. Few words in market vocabulary are so good at taking something bad and making it seem like a good thing, like a friendly adjustment to a mistake.
Corrections shouldn’t be confused with a crash or just a bad day in the markets; they are generally shorter-lived and less severe. While a stock or sector can experience a correction before the broader market, a correction in a major index like the S&P 500 often impacts sentiment across the entire market.
Investors should be prepared for corrections, which are a regular feature of healthy markets. Having a well-diversified portfolio and a long-term investment strategy can help weather these periods of volatility.
8. Dead Cat Bounce
A dead cat bounce is the most dismally evocative phrase on our list. However, it gets the point across, reflecting a giant fall with only a modest “bounce” afterward. It’s also meant to articulate the idea that one shouldn’t read too much into a minor uptrend after a steep fall: Even a dead cat will bounce if it falls from a great height.
In the markets, it’s a temporary recovery in asset prices after a substantial drop, followed by again heading downward.
9. Flight to Quality
Flight to quality is the tendency of investors to seek safer, more stable assets during times of market stress or economic uncertainty. This typically involves moving money from riskier investments like stocks or junk bonds to more secure options such as U.S. Treasury bonds or gold.
During the early stages of the COVID-19 pandemic in 2020, many investors engaged in a flight to quality, driving down yields on U.S. Treasury bonds as demand for these safe-haven assets surged.
10. Implied Volatility
Implied volatility refers to the estimated changes in a security’s price and is generally used when pricing options. Unlike historical volatility, which looks at past price movements, implied volatility is forward-looking and derived from current option prices. In general, implied volatility increases when the market is bearish—when investors believe that the asset’s price will decline over time—and decreases when the market is bullish—when investors believe that the price will rise over time.
The CBOE Volatility Index, commonly known as the VIX, is the most widely watched implied volatility measure. Often called the “fear index,” the VIX tracks the 30-day implied volatility of S&P 500 index options.
Here’s how to interpret the VIX:
- A VIX reading below 20 is generally associated with stable, stress-free periods in the market.
- Readings between 20 and 30 suggest increasing uncertainty.
- Values above 30 indicate high levels of investor fear or uncertainty. This is where it might be heading when there’s a major sell-off.
For example, during the market crash in March 2020 due to the COVID-19 pandemic, the VIX spiked to over 80, reflecting extreme market stress and uncertainty.
11. Inflation
Simply put, inflation is the rate at which the level of prices for goods and services rises, which can drive the purchasing power of a currency lower. The U.S. Federal Reserve pays particular attention to rising inflation when it sets overnight lending rates or the Federal Funds Rate.
In the early 2020s, the Fed raised rates significantly to combat inflation. This raises the cost of borrowing, which can impede growth and thus profits. However, the Fed often tries to thread the needle of allowing enough growth to maintain rising employment numbers but not enough to cause high inflation, which destroys the value of the dollar.
The chart below reflects recent changes in the Fed funds rate, which increased significantly with inflation after the pandemic.
12. Margin Call
A margin call is a broker’s demand that an investor deposit more money or securities into their account when the value falls below a certain threshold. This occurs when an investor borrows money to buy securities, a practice known as buying on margin.
For instance, if an investor buys $10,000 worth of stock with $5,000 of their own money and $5,000 borrowed from their broker, a significant drop in the stock’s value could trigger a margin call. The broker may require the investor to deposit more funds or sell some securities to cover potential losses.
13. Oversold
Oversold is a technical term for when an asset is trading below what analysts consider its true value. This often happens during panic selling, when emotional reactions rather than fundamental analysis drive trading decisions.
Technical analysts use various indicators to identify oversold conditions, such as the relative strength index (RSI). When the RSI falls below 30, it suggests the asset is oversold and due for a rebound. However, it’s crucial to note that oversold conditions can persist, especially in a bad market.
14. Short Selling
Short selling is a bet that a security or index will decline. The short seller borrows shares to offer for sale. The idea is to sell the shares, of which the short seller has no ownership, at a higher price while hoping that the price falls by the time the trade needs to be settled. This would mean that when the short seller buys the shares at the lower price and delivers them to the buyer, they make a profit from the price difference.
While short selling can be profitable if done right, it can amount to massive losses if the trade goes the other way. It’s not a strategy for beginners.
15. Volatility
Technically speaking, volatility is a statistical measure of the dispersion, or returns, for a given security or market index. That’s another way of saying it’s a measurement of change (or beta) of a security or index against its normal patterns or benchmarks it is weighed against.
As we noted above, one way of measuring volatility is to look at the VIX. There are many other ways to measure volatility, depending on what you are looking at or measuring. If you think of it as a measurement of the rate of change that reflects uncertainty or risk, you are on the right track.
What Qualifies as a Stock Market Crash?
A stock market crash is a sudden, steep decline in stock prices, typically 20% or more from recent highs over a few days or weeks. Unlike corrections or bear markets, crashes are characterized by their rapid, often unexpected nature. The 1929 Wall Street crash and the 1987 Black Monday crash are classic examples.
How Is a Crash Different from a Correction or Bear Market?
While all involve market declines, they differ in severity and duration:
- A correction is a 10% decline from recent highs, often lasting days to weeks.
- A bear market is a 20% decline, typically lasting months or even years.
- A crash is a steep, sudden decline of 20% or more, usually occurring within days.
How Is a Crash Different From a Panic?
The 19th century was rife with periodic market panics—and were named as such. Since more precise terminology took hold (like recession, depression, etc.), a panic refers to a widespread sell-off of a stock, a sector, or an entire market because of fear, rumor, or overreaction rather than reasoned analysis.
Should I Buy When the RSI Is Low?
A stock might be considered oversold if its RSI is below 30. This is based on the idea that the security is poised for a rebound. However, the reliability of this signal will depend in part on the overall context. If the security is caught in a significant downtrend, it might continue trading at an oversold level for quite some time. Traders in that situation might delay buying until they see other technical indicators confirm their buy signal.
The Bottom Line
Just as you wouldn’t want to be stuck in a foreign country not knowing the language when an emergency strikes, knowing the vocabulary of stock sell-offs is crucial for navigating turbulent market conditions. Terms like “volatility,” “corrections,” and “contagion” point to key metrics and the events they measure during a sell-off.
Though often unsettling, sell-offs are a natural part of market cycles and can present prospects for prepared investors. Knowledge is power in investing, especially when markets are in flux.