A Layman's Guide to the Finance Industry's Cryptic Jargon

By the time of George Washington's first inauguration, held in 1789 at Wall Street's Federal Hall, people had been trading in stocks and bonds under nearby shade trees for more than 100 years. Early American businesses had little access to capital of their own, and they generally turned overseas to get it. This activity soon centered on Wall Street, a convenient location because of its proximity to New York City's ports. The system was simple: Companies would either sell ownership shares or issue bonds (loans that they promised to pay back with interest) as a way of raising hard currency. Owners of those stocks and bonds could then sell them to other investors, ideally at a profit.

These days the system works roughly the same way—it's just bigger, richer, and infinitely more complex. The overriding function remains the same: to distribute capital efficiently. But the system has become increasingly byzantine over time, adopting a language all its own, and effectively creating an ecosystem in which those who control the flow of money can take advantage of its intricacies to siphon funds for themselves.

Wall Street can therefore seem like a very private club. But in fact anyone can participate; the barriers to entry are as much linguistic as they are financial. With that in mind, here's a primer on the A to Z of the financial multiverse.

ART: "Well, Chuck, we could have bought a Rothko with your lottery winnings, but you had to blow it all in the stock market because you thought you were a master of the art of asset accumulation."

Depending on whom you ask, finance can be an art, a science, both, or neither. The 2013 recipients of the Nobel Prize in Economic Sciences won theirs for an analysis of asset prices. Traditional sciences, however, are built on testable hypotheses. Not so with economics. As the influential former hedge-fund manager and author Nassim Nicholas Taleb writes, in economics you "can disguise charlatanism under the weight of equations, and nobody can catch you since there is no such thing as a controlled experiment."

But economics isn't really an art, either. Some investment managers claim a special ability to "generate alpha" (to earn a higher-than-expected return), but their claims are rooted more in clever marketing than in actual evidence. What we're left with is a field that is neither art nor science but has elements of both.

BULLS AND BEARS: "The market was behaving bullishly before the Supreme Court scandal, but now that we all know that Ruth Bader Ginsburg is actually undead it's become a bear market."

If you visit Wall Street, you'll notice Charging Bull, a 16-foot-long bronze sculpture standing a few blocks from the New York Stock Exchange. The statue was installed in the wake of the 1987 stock-market crash, and it illustrates well why the bull is the traditional symbol of a rising stock market: It appears to be charging forward, head lowered, nostrils flaring, eyes wide and angry. Stocks surge mostly in unison, sometimes in great leaps and often for no discernable reason. If the bull represents a rising market, the bear symbolizes a market in retreat: A falling market is like a slumbering bear.

CONCEPT OF MONEY: "My dad never believed in the concept of money, but growing up in the woods did teach me a lot about forestry."

In prison, inmates often use postage stamps as currency. The system works because everyone trading the stamps agrees a stamp has value beyond that of a simple stamp. If one day prisoners decided stamps were worthless and that they were going to trade cigarettes instead, the guy with a pillowcase full of stamps in his cell would be hosed. It's proof that modern money is a mental construct.

DIVERSIFICATION: "Diversify your bonds."—GZA

When investing, it's a good idea to spread your money around instead of concentrating in a single company or sector. A good way of diversifying is by buying into a variety of categories called asset classes. These include American stocks, international stocks, and government bonds, among others. The idea is that these will gain and lose value at different rates and times, keeping your portfolio stable.

EQUITY: "I paid thirty dollars for this T-shirt, but then Karl Lagerfeld spat on it, so it's now worth two hundred. I guess my equity increased a hundred and seventy?"

There are around 5,000 publicly traded companies in the United States, ranging from multinational corporations like Apple to low-value stocks like Zoro Mining. They are divided into shares, which are a form of "equity security." The total value of a company (i.e., its market capitalization) is determined by multiplying the current stock price by the total number of shares.

FEDERAL RESERVE: "I don't really know what the Federal Reserve Bank does, but I read on the internet that it's impeding my ability to build an underground bunker to protect my family from the apocalypse."

The Federal Reserve is the United States' central bank. It occupies a singular position in our economy: In addition to serving as the bank to the federal government, it's tasked with managing the growth of the economy. It accomplishes this by setting short-term interest rates through open-market operations and by issuing credit to private member banks—effectively creating money out of thin air.

GREED AND FEAR: "My greed led me to invest in a chain of artisanal barber shops, but fear that the haircuts were subpar led me to sell my shares prematurely."

These are the two emotions that drive the markets. When the market rises, investors are tempted to jump in and get their share of the gains; when stocks fall, those same investors tend to unload.

HEDGE FUND: "I managed a hedge fund until 2008, but then the recession hit and now I mow lawns for a living."

The degree to which people talk about hedge funds is inversely proportional to how good an idea it is to invest in one: Hedge funds are opaque private investment funds designed mostly for the very wealthy and run by high-profile investment managers. Historically, they've been largely unregulated. Managers often exercise wide latitude, utilize exotic strategies, and collect outsize fees.

INDEX: "The economics student burst into tears after discovering an alternate index that contradicted his entire thesis."

Wall Street measures everything, including growth and shrinkage in the economy and financial markets. Indices are the instruments they use. The Dow Jones Industrial Average is perhaps the most familiar index—it measures the second-by-second stock-price movements of a group of 30 giant companies. There are dozens of lesser-known indices, measuring employment, bond markets, individual sectors, and markets in countries and regions around the world.

JOB: "Your job could be the foundation of your savings, if you'd just stop ordering Seamless every single night."

Assuming an annual growth rate of 5 percent, a 25-year-old currently making $30,000 can expect to earn upward of $3.5 million over the course of a 40-year career. By comparison, Goldman Sachs CEO Lloyd Blankfein received compensation totaling $23 million in 2013. While such immense remuneration is the domain of a tiny fraction of the populace, most Americans living beyond hand-to-mouth are largely responsible for creating and managing their own savings plans.

KEYNES: "That was very Keynesian of your parents to pay your rent this month so you could pursue your dreams of being a conceptual haiku poet."

John Maynard Keynes (1883–1946) was a British economist who argued—as his adherents still argue—that government intervention can bolster economic activity in times of stress. The massive stimulus package in response to the global financial crisis of 2008 was an example of Keynesian economics.

LIQUIDITY: "I can't find someone who'll take all of this Coca-Cola stock off my hands. Guess it's not very liquid."

A liquid asset is one that can be turned into cash quickly. A bank account provides constant liquidity because you can turn it into cash at the nearest ATM whenever you want. Real estate, conversely, is illiquid: It may be worth a million dollars, but turning it into cash via a sale can take months or years. Stocks and other securities are usually considered to be highly liquid—but some stocks are more liquid than others. Fifty-five million shares of Apple change hands every business day: Apple has high liquidity. Thinly traded stocks may be illiquid because a seller may not find a ready buyer. Sellers far outnumber buyers during a panic, creating a liquidity problem.

MARKET CYCLE: "The market cycle dictates that, ultimately, there will be consumer demand for a nu-metal revival."

Stock prices tend to follow a pattern: They rise for a few years, peak, then retreat before turning around and rising again. These market cycles are related to business cycles: Rising employment, production, and trade indicate a period of expansion, which may last for years before peaking at the onset of a recession—a contraction lasting half a year or more. The two most severe contractions of the last 100 years have been the Great Depression of the 1930s and the so-called Great Recession of 2007–09.

NOISE IN THE SYSTEM: "I took advantage of all the noise in the system to cherry-pick the data points I needed to empirically prove that Seinfeld should still be on TV."

Wall Street thrives on data—economic data, market data, as well as data from corporations, governments, and institutions. Every day large amounts of data points are heaped onto an already staggering pile of historical statistics. Add to all that the constant flow of information and opinions from the financial press, as well as the chatter from thousands of participants, observers, and analysts, and you have one massive, extremely noisy system.

OPTIONS: "Norm Macdonald optioned the sitcom rights to my Tumblr, and now Cats That Look Like Janet Yellen is stuck in development hell."

An option contract gives the holder the right to do something—or not—for a certain period of time. The two most common forms of options are calls and puts based on stocks. For a fraction of the stock price, you can take an option to call (buy) or put (sell) a stock at a predetermined price until the option's expiration date, when it becomes worthless. Until that time, you can trade the option contract just as you would trade a stock. Most investors never venture near this specialized corner of the Wall Street ecosystem.

PRODUCTS: "I had a panic attack trying to decide which product best suited my needs as an investor and ended up with a low-yield mutual fund concentrating in the cheese sector."

There are other investment vehicles beyond simple stocks and bonds. Mutual funds are ready-made portfolios, professionally managed and conveniently packaged for the ordinary investor. Exchange-traded funds (ETFs) are similar, but while most mutual funds are actively managed, ETFs are usually designed to simply mirror an index. ETFs are usually less expensive to own.

Brokerage firms are the stores where investment products are bought. Full-service firms like Morgan Stanley and Merrill Lynch (owned by Bank of America) are staffed by highly paid salespeople inhabiting plush surroundings and pushing products from the firm's inventory. Discount firms like TD Ameritrade and E*Trade offer a wider selection but leave the investor to choose his own products. Registered investment-adviser firms offer a hybrid model: The adviser typically designs a portfolio, populates it with products from a discount broker, and maintains it with periodic rebalancing trades.

QUANTITATIVE EASING: "Thanks to quantitative easing, my bank suddenly had money to lend, but I decided to stay hidden in my underground bunker anyway."

When the country plunged into recession in 2008, one action taken by the Federal Reserve to inject liquidity into the banking system was the policy of quantitative easing. This involved buying trillions in assets from member banks. QE had the effect of supplying ready money the banks could use to lend out or bolster their own cash reserves. Through three rounds of QE, the Fed pumped an estimated $4.5 trillion into the economy. Some observers claim QE created the monetary equivalent of a drug habit and warn that another crisis will occur when the Fed tapers its buying.

RISK/REWARD: "I risked it all by investing in a line of iPad cases made from Bernie Madoff's old clothes, but no one bought them and my reward was losing all of my money."

One of the few universally accepted laws of investing is that risk and reward are roughly equivalent. Holding stock in a corporation offers the possibility of appreciation—but the company could also go bankrupt and render the stock worthless. A less established company runs a greater risk of crashing and burning, but there's also the possibility it could become the next Apple and make you rich. Bonds are generally considered to be safer but offer a more limited upside. Cash in the bank is guaranteed by the FDIC, but it's also guaranteed to do next to nothing in the way of growth.

SECURITIES AND EXCHANGE COMMISSION: "The SEC ignored my repeated requests to investigate Bernie Madoff's Ponzi scheme, even though it's their express job to do things of that nature."

The Securities and Exchange Commission (SEC) is the federal agency responsible for enforcing the country's securities laws and regulating the securities industry. In addition to overseeing the investment markets, it is tasked with protecting investors by forcing public companies to disclose meaningful financial information about themselves to the public, allowing all investors access to the same facts so that they might make smart investment decisions.

TACTICAL VS. STRATEGIC: "Last year, I invested tactically and spent hours each day trading. Eventually, I decided I should invest strategically so I could have more time to go outside and walk my dog."

Modern investment strategies are governed by two opposing methods: tactical, which involves frequent short-term trading in response to the market and economy, and strategic, which is more of a set-it-and-forget-it approach. Proponents of tactical investing claim that well-timed moves can reduce risk. Adherents of the opposing view point out that frequent trading increases costs and that market timing has never been proved to work consistently.

UNITED STATES OF AMERICA: "The United States of America remains the powerhouse of an increasingly global economy."

The US represents less that 5 percent of the global population but 49 percent of world stock markets by value. (Great Britain and Japan are tied for second place with 8 percent each; China represents 2 percent.)

VANGUARD: "I recently bought some Vanguard funds and took the money I saved by not having to pay commission to buy my dog a diamond-studded collar."

According to the Investment Company Institute, there were 801 mutual fund companies operating in 2013, offering an array of more than 15,000 individual funds. The largest of those companies is the Pennsylvania-based Vanguard Group, which offers 123 separate funds of its own. Vanguard sells no-load funds, which aren't sold by brokers because they don't carry a commission. Load funds, on the other hand, pay brokers a commission—an extra cost borne by the investor.

WORLDWIDE ECONOMY: "The worldwide economy was vastly affected by the Irish Potato Famine, as it led to a diaspora that spread young Irish people throughout Europe and America, disrupting the supply of labor in those countries."

For centuries, each individual country's economy was seen as a stand-alone entity. It was only recently that we understood that independent economies do not exist. Information, capital, and material goods move around the Earth at speeds unforeseen just a few decades ago. No single country or region is now immune from global impacts: China, to offer a stark example of interdependence, owns more than $1.2 trillion in US government debt, and its vast and cheap labor force builds a significant portion of the products we use. But if China stopped buying bonds or selling electronics—or if we stopped buying those electronics—both countries would be in big trouble.

X CHROMOSOME: "There was no line for the women's bathroom at Goldman Sachs because of all the humans with only one X chromosome in the building."

It's hard to deny that there is a gender gap on Wall Street. There are no female CEOs at major financial firms, and only 17 percent of top executives at those firms are women. Meanwhile, only 22.5 percent of new first-year analysts in 2013 were female. It's not just a gender gap: 65 percent of the new class were white, 29 percent Asian, and only 6 percent were black or Hispanic.

YIELD: "The value of the family cow was a thousand dollars, but its yield was four hundred dollars' worth of milk per quarter."

There are two elements to an investment's return: capital appreciation and yield. Costco stock was trading at around $112 a year ago and, as of this writing, was hovering around $127, reflecting capital appreciation of $15. Yield is the current income the asset produces; it comes in the form of a dividend in the case of a stock, interest if it's a bond. Costco's most recent quarterly dividend was 35.5 cents per share. With a share price of $127, a year's worth of $.355 dividends translates to a dividend yield of 1.1 percent. Do some quick math and you come up with a total return of $16.42, or 14.7 percent.

ZUCCOTTI PARK: "Why are your boots so muddy and smelly?" "I was protesting with the rest of the 99 percent at Zuccotti Park!"

This is a privately owned park in lower Manhattan where Occupy Wall Street protesters camped out to decry income inequality in America and to critique the way in which our financial system operates. It provided a place that stood as the philosophical antithesis of Wall Street—anyone could occupy its space, and instead of complicated terminology it offered direct chants in the face of power. While exploring the world of finance, it's important to remember that Wall Street is not an abstraction: It's a power center whose actions affect real people.