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b"5 Investing Terms You're Probably Using Incorrectly
Like most professions, finance has a language of its own. If you\\u2019re not part of the club\\u2014and even when you are\\u2014it\\u2019s easy to get the lingo wrong, and that can lead to some very expensive mistakes.
To help you avoid that, I\\u2019ve compiled a list of some of the most frequently misused words in finance\\u2026and what they really mean.
1. Volatility
A lot of people mistakenly think that volatility is the same as uncertainty and use the two words interchangeably. Volatility is also often framed as a bad thing, especially when people talk of \\u201ctoo much volatility\\u201d in the markets.
But volatility is just a way of measuring the change in the price of an investment over a particular period of time\\u2014 whether stocks are going up or down, the amount they move either way, is the stock\\u2019s volatility.
Let\\u2019s say you have two companies, Company A and Company B, and both have an average share price of $30 over the past month. But if Company A had a bigger price swing than Company B, its stock is the more volatile of the two.
So when a stock has low volatility, it typically does not make extreme moves away from its average price. And when a stock has a lot of volatility, its price swings are bigger. But these movements are simply short term\\u2014and here\\u2019s the key: For assets held over a longer period of time, these day-to-day movements have little impact on performance.
One other note about volatility: A lot of people are afraid of it, but, if used wisely, volatility can be your friend. If you are buying, use downward volatility to buy; if you are selling, use it to sell. Be the master of volatility; don\\u2019t let it master you!
2. Cheap vs. Expensive Stock
I\\u2019m sure many of you have heard investors look at the price of a stock and make a declaration about whether it\\u2019s \\u201ccheap\\u201d or \\u201cexpensive\\u201d. In this misused version of the term, shares of Apple are deemed \\u201cexpensive\\u201d if they\\u2019re around US$110 per share. But shares of a healthcare company\\u2014we\\u2019ll use Affymetrix as an example\\u2014which trades around US$14 per share are deemed \\u201ccheap.\\u201d
But the price of a stock has nothing to do with whether it\\u2019s cheap or expensive. When financial professionals talk about cheap and expensive stocks, they are referring to what they see as a stock\\u2019s value relative to its long-term fundamentals and current earnings. So, for example, they may look at the price per share and compare it to the earnings per share and come up with a ratio called the price to earnings ratio or P/E.
In this case, Apple\\u2019s P/E is 12 and Affymetrix sports a P/E of 117. So Apple shares are cheap, and Affymetrix shares are nosebleed expensive, based on current earnings. So price and value are not necessarily related.
3 Median vs. Average (or mean)
This one takes me back to elementary school math, but there\\u2019s an important difference between median and average (often also called the \\u201cmean\\u201d). Both median and mean refer to a midpoint in a series of numbers, but the way they\\u2019re calculated is very different.
Let\\u2019s say there are 7 people in a classroom, 6 kids and one teacher. Here is a list of their ages: 5, 6, 6, 7, 7, 8 and 36
The average (or mean) age of everyone in the classroom is calculated by adding all the ages and dividing by the number of people. So the sum of the ages is 75 and dividing by 7 results in an average age of 10.7 years.
But we already know that, if all the kids are 5-6-7-8-years-old, an average age of 10.7 doesn\\u2019t really describe the scene because, of course, the teacher\\u2019s age skews the results. The mean isn\\u2019t representative of the age of everyone in the room since six of the seven people in the room are younger than the average age.
A more accurate indicator is the median age. The median is calculated by arranging the values from lowest to highest and picking the one in the middle \\u2013 which works out to 7 years. So, the median age is 7."