'Second Derivative'? Why Market Jargon Is Evil

Wall Street has always sounded strange to outsiders. Swing trades, naked calls, silent partners and straddles seem like they belong in Hugh Hefner’s memoirs, not an investment guide.

Don’t fault a practitioner for saying "straddle," though. It’s a short, old word (the kind Churchill said are best) used to describe a complicated thing that few people need to know about (but if you must, it's an option strategy used to bet on a big stock move without specifying the direction). Save your scorn for those who do the opposite — use complicated words to muck up simple, important financial ideas. They puff themselves up but confuse beginners who, be assured, can ill afford more confusion.

Half of Americans don’t know what a subprime mortgage is. Two-thirds don’t know how much of 8 is left over after taking away 25%. Half can’t say what the Dow Jones Industrial Average is — even when given a handful of choices. (This is according to surveys conducted over the past year by the Center for Economic and Entrepreneurial Literacy, a nonprofit.) Chuckle at these people, but weep for yourself, since financial ignorance has a ripple effect. Credit card defaults and house foreclosures hit record highs this year. Both cause bank losses which in the extreme become government losses. Those are paid by us through higher taxes if we’re lucky and devalued money if we’re not.

Needlessly nerdy financial words cost all of us, you might say, to the extent they keep our neighbors too intimidated to learn. Those of us who use them (neither I nor my favorite writers are blameless) must break the habit. In the schoolyard, pomposity used to have a quick remedy — a sharp, upward tug of the back elastic of the offender’s underpants, called a wedgie. Legally, I can’t recommend that you use it to punish those who use the four self-important terms below. That said, if you hear someone use one of the terms, and if you happen to be standing behind them, and if you love America and you’re not holding a dangerously hot coffee at the time (or if it at least has a lid), I think we both know what needs to be done.

This one’s newly fashionable. Factiva, a subscription news database, shows that financial publications mentioned it 100 times in the past three months, vs. no mentions during the same period two years ago.

Someone who says the second derivative of a financial measure is improving means things are getting worse, but at a slower pace than before. The term comes from calculus, the study of change. In the tidy exercises presented in business school course books, second derivatives show when graphs are nearing maximum and minimum points. In the messy real world, where changes in things like the unemployment rate and level of consumer confidence can’t be calculated into the future, second derivatives don’t explain much of anything, beyond what’s obvious to anyone looking at a chart.

Note that "second derivative" seems to be part of a binary jargon system, often accompanied in use by "green shoots." I haven’t studied agriculture formally, but green shoots seem like an even brighter sign than an improving second derivative, since they suggest something is moving in the right direction (albeit almost imperceptibly) as opposed to moving in the wrong direction (albeit more slowly).

Mutual fund managers love to promise to find "alpha" for their customers. Studies have long shown that four out of five of them don’t. Financial mathematicians long ago decided that each stock’s return is directly related to its risk, which is an innocent enough assumption until we try to define risk. In one common but flawed approach, a stock’s risk is defined by its past trading volatility. The measure is called beta, and knowing a stock’s beta alone is supposed to help us predict its returns. (It doesn’t.) Alpha is any return achieved beyond that predicted by beta. Someone who boasts about producing alpha is saying they secured good returns given the level of risk their math model says they took. Congratulate them heartily on this theoretical accomplishment.

I’m not going to search my story archives for this one for fear I’d have to hoist my own elastic. Factiva shows the word used more than 8,000 times over the past three months in stock market stories. There’s no harm in using "home equity" to describe the portion of a house that is owned free and clear. "Private equity" is fine for referring to ownership stakes in companies that aren’t traded on exchanges. For stocks, though, there’s a better word. It’s stocks. Also, shares.

Note that the ugliness of "equities" is compounded when it’s used with bad words for other asset classes. A young saver hearing that equities tend to outperform debt over long time periods must wonder how all of it relates to the stock and bond funds available in his retirement account.

Not all short words are good. A basis point is one-hundredth of a percentage point, or 0.01%. The term "basis points" is abbreviated bps. People speaking the abbreviation over the years have somehow inferred the extra letter to yield "bips."

Bond traders are busy, informed people. It’s OK for them to say "thirty bips" to each other. High-fiving, goatee-wearing pundits with their shirt sleeves rolled up at the financial channel news desk are, despite appearances, not too busy to say "thirty basis points." Then again, fewer than one-third of respondents in a survey conducted by AARP Financial knew what a basis point is. Maybe our excitable pundits should slow things down even further and say "three-tenths of a percentage point." That way, Joe Public won’t have to learn a second language to figure out what might become of his adjustable rate mortgage.

This list is only a start. Kindly add the ugliest financial jargon you can think of to the comments section below.

Jack Hough is an associate editor at SmartMoney.com and author of "Your Next Great Stock."