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In trading, large sums of money can be lost due to confusion caused by the use of imprecise language. That's why it's important to use appropriate terminology. The proper use of the following expressions removes ambiguity because they describe trading activity in precise terms.

This precise language may seem unnecessary to the untrained novice. However, to the experienced trader, who may have lost money on a trade or has witnessed a good trade get “busted” due to confusion caused by imprecise terminology, this is more than mere semantics.

Trading terminology can be confusing at times and often seems unnecessarily complicated. However, there are a few expressions that are critical to your understanding of both technical analysis and trading in general. Certain terms allow traders to express a concise thought in one or two syllables.

Trading errors can be expensive, and often there are tremendous sums of money on the line, so it's important that every party involved in the trade understands exactly what is taking place.

First, we will briefly discuss three important terms – “long,” “short,” and “flat.” What do these terms mean?

Long– When a trader expresses an intention to go long, he or she is placing a trade that will only become profitable if the price increases. The trader wants the price to rise; if it falls, the trader loses.

Context: John is long ABC because he likes their new line of products.

Short– When a trader expresses an intention to sell short, he or she is placing a trade that will only become profitable if the price declines. The trader wants the price to fall; if it rises, the trader loses.

Context: Jane shorted XYZ just before earnings; she thinks the company might be in trouble.

The obvious question is, why don't traders simply say, “I'm going to buy stock XYZ” instead of “I'm going to go long XYZ”? In this case, the word “buy” is an imprecise term. In the world of trading, the term “buy” could mean two different things.

A trader might buy XYZ because he or she believes the price will rise. Or, a trader might buy XYZ because he or she is currently short shares of that stock. Those are two very different situations. A trader who is short a stock must buy shares if he or she wishes to exit or “cover” the short position.

Similarly, why don't traders simply say “I'm selling ABC” instead of “I'm shorting ABC”? A trader who is selling ABC might already own the shares. Perhaps this individual wishes to sell in order to exit the trade.

It's also possible that this person may wish to sell ABC short. However, there can be no confusion if a trader states that he or she is “short ABC.” This trader will turn a profit if stock ABC falls, and will lose money if ABC rises.

Flat —The trader is neither long nor short. This trader has current position in the market.

The act of being flat can indicate the mere absence of a trade, but it can also represent a strategic decision. This is particularly true of short-term traders, who may wish to avoid the volatility associated with an economic report, an election, or a speech given by a central bank official. Often, such traders wait for the event to pass and then reassess the situation before reentering the market.

Context: John entered the weekend flat because he's going away on vacation.

There is additional terminology that is important to understand as it relates to trading. Here are some supplementary key terms:

Position– If a trader invests in XYZ in anticipation of making a profit, that trader has established a “position” in XYZ. A position can be long or short, and may involve any trading instrument – stocks, bonds, currencies, options, and so on.

One position can be used as a “hedge” against another position. This means the trader is using one position to protect or provide insurance against a potential negative move in another position.

Most hedge funds are capable of taking long and short positions simultaneously. Mutual funds and institutional traders have demonstrated a tendency to build positions over a period of weeks or months, while individual traders tend to enter and exit positions more freely.

Any position that is still in effect is referred to as an “open position”; after the trader exits that position, it is referred to as a “closed position.” A position can be entered all at once, or it can be built over a series of trades.

For example, some traders prefer to initiate a position with a small trade and then add to it if the price moves in their favor. Others maintain a long-term “core” position in a stock, commodity, or currency while adding and subtracting short-term “trading” positions.

Context: John has closed his long position in XYZ and is planning to enter a short position in ABC.

Entry —The point at which the trader initiates a long or short trade or a portion of that trade. An entry can occur “at market,” which means the trader is willing to accept whatever price is currently available. Or, the trader can use a “limit order,” which defines a specific entry price.

Context: Jane is checking the charts to find a good entry point for ABC.

Stop Loss– The predetermined point at which a trader accepts a loss and exits a trade. By placing a stop, the trader attempts to define his or her risk. By accepting a small loss, the trader eliminates the possibility of a large loss.

Context: Jane placed her stop just beneath ABC's recent low point. If ABC reaches a new low, she'll automatically exit the trade.

Target– The predetermined point at which a trader intends to take a profit. By using a target, a trader defines the trade's potential reward. Some traders prefer to use multiple targets as a means to stay in winning positions longer.

Context: John closed half of his position at his first target and hopes to close the other half at the second target.

Time Horizon– This refers to the length of time that the trader plans to remain in the trade. A “day trader,” someone who enters and exits a trading position on the same day, has a very short time horizon, while a mutual fund might have a time horizon that is measured in years.

One trader may operate within multiple time horizons, but it's important to remain consistent once the trade has been entered. It's usually a bad idea to turn a short-term trade into a long-term position just because the trade isn't working out as planned. Yet if we look into the account of an average investor, we might find unprofitable long-term positions that started out as short-term trades.

Context: John is an extremely impatient trader; he has the time horizon of a fruit fly.

Time Frame– This term refers to the length of time measured by each point, bar, or candle on a chart. Commonly used time frames include the weekly, daily, 240-minute, 60-minute, 30-minute, 15-minute, 5-minute, and 1-minute charts.

Context: For her time frame, Jane analyzes the overall situation on the daily chart before searching for trade setups on the hourly chart.

Bulls and Bears —The terms “bull” and “bear” appear frequently in trading literature, but what is the origin and significance of those terms? An upward movement is considered bullish because the attack of a bull occurs in an upward motion. An attacking bull lowers its horns and then thrusts them sharply upward.

Context: U.S. Dollar bulls pushed the currency to a new six-month high today.

Conversely, an attacking bear swats downward with its paws, which is why a downward move in the market is referred to as bearish. Images of these two beasts engaged in battle with one another, with the bull thrusting its horns higher while the bear swats downward from above, hang in the offices of brokers and traders around the world.

Context: The huge rally in metals prices has gold bears on the run.

Trend —A “trend” is a directional bias in price movement. Trends are important because they give traders an edge; if the price is moving persistently higher or lower, traders will attempt to exploit this movement by taking trades that favor the direction of the trend. The concept of trend trading is used as the basis of many popular trading strategies.

In technical analysis, an “uptrend” is represented by a series of higher low prices and higher high prices. Conversely, a “downtrend” can be accurately described as a series of lower high prices and lower low prices. Trends can remain in effect for months or years. Almost all trends end eventually, but attempting to guess when a trend will terminate can lead to hazardous trades and disappointing results.

Context: Jane established a long position in ABC because of the stock's strong upward trend.

In Figure 2.1, we see a sustained uptrend on the daily chart of the U.S. dollar/Japanese yen currency pair (USDJPY) that formed in the early part of 2013. This is an upward trend because it consists of a series of higher high points (HH) and higher low points (HL).

Figure 2.1 A Series of Higher Highs and Higher Lows in USDJPY

Similarly, a downtrend consists of series of lower highs and lower lows. This concept is demonstrated in Figure 2.2, which shows shares of Herbalife Ltd. (HLF) forming a series of lower highs (LH) and lower lows (LL) starting in early 2014. Trends can occur in any time frame, and are not limited to long-term charts.

Figure 2.2 A Series of Lower Highs and Lower Lows in Shares of Herbalife (HLF)

Context: When John noticed the prolonged downtrend, he knew he wanted to open a short position.

Fade: When a trader takes a position in opposition to a stock's movement, he or she is said to be “fading” that move. Possible reasons for fading a move include the following: The trader is expressing a lack of faith in the move; or believes that the market has misinterpreted a news item; or believes that the market has moved too far, too fast, and that the price is likely to return to a previous level. This term can be applied to a bullish or a bearish move.

Context: John felt the market overreacted to the strong employment report, so he faded the rally in the S&P 500 futures.

The more you use the terminology, the more comfortable – to the point of becoming second nature – it becomes. Most importantly, it leaves no questions about what you are doing and where you stand with your trades.

Final Thoughts on the Language of Trading

Trading terminology is indeed a language unto itself. The ability to understand and apply that language is critical when communicating with banks, brokers, and other market participants. In many cases, the lingo used by traders allows them to describe a situation with precision and effectiveness. It is also a means by which a trader can identify other traders.