Glossary

arbitrage

In short, first the identification of a discrepancy between the price of a security and what it “should” be, according to fundamental analysis or technical analysis, and then the exploitation of this discrepancy for the capture of profit. Arbitrage can be conducted in a number of ways, depending on the market or the security. See, e.g., statistical arbitrage.

arbitrageur

One who engages in arbitrage.

ask

Lowest price a seller is willing to accept for a security.

bid

Highest price a buyer is willing to pay for a security.

direct market access

Exchange technologies that enable so-called buy-side firms direct access to the order book of an exchange, bypassing sell-side firms or their own in-house brokers.

E-Mini S&P

Index futures product linked to the S&P 500 Index. The contract trades at $50 times the value of the index. Recent volumes of the contract were upward of 1.8 million meaning the value of daily trades is more than $120 billion.

fundamental analysis

Form of financial analysis based on so-called fundamental properties of a security, such as a firm’s profit, its performance in relationship to the performance of other firms in its market segment, and broader changes in the economy (e.g., interest rates). See also technical analysis.

limit order book

The list of open limit orders consisting of the set of bids and asks. The limit order book has often been available only to specialists and/or market makers and therefore not visible to the public. With the move to direct market access, so-called buy-side investors are now able to interact with the limit order book without the need for an intervening broker.

noise trader

One who is assumed to be unable to distinguish between “valid” and “invalid” information within a market. Although noise traders should not be able to survive within a market owing to the quick exhaustion of their capital, recent models and empirical evidence have shown otherwise.

open-outcry trading

Material and bodily form of trading whereby offers to buy or sell a security are settled through specific hand motions and vocal shouts. In the Chicago Board of Trade, such activity is done in the “pits,” a series of raised steps that also determines position within the social hierarchy of traders. Such trading has diminished greatly in importance with the rise of electronic communication networks.

proprietary trading

Trading conducted with the firm’s own capital rather than with the capital contributed by its clients.

security

A financial asset that can be traded. Common securities include stocks (shares in a corporation), bonds (a debt that must be paid with interest), and derivatives. As long as one can “package” an asset into something that can be traded, and there is a market for buying and selling it, one can create a security.

spread

The difference in price between the bid and the ask.

statistical arbitrage

See technical analysis.

technical analysis

Form of financial analysis based on observable properties of market data, such as the temporal sequence of the price and volume of a security, that aims to understand how such data fit into previously defined patterns that might suggest future changes in the security. In its most advanced form, technical analysis develops a statistical model based on prior data to predict future movements. When a deviation from this model is found, it is a potential arbitrage opportunity, leading to the term statistical arbitrage, a key technique in high-frequency trading. See also fundamental analysis.