Some people look at the stock market as a gamble, but successful investors look at the stock market as a calculated risk. When the market plummets people run away scared. But as Warren Buffett has always said… “Be greedy when others are fearful”.
We are at the end of a bull market, and over the next year the market will be volatile, but after this period it will recover. During this time I will be reshuffling my portfolio to align with the changes going on.
To do this I had to remind myself of the 1 important measure all investors need to take:
- Understanding the difference between speculation and investing
To cut things short, speculation is a bet, you do very little research and gamble on a stock going up or down. Whereas investing is a calculated risk you make after extensive research.
What Is Speculation?
In the context of investing, speculating is like a hand in black jack, there can be lots of winning hands, but you have no idea what the next card is, what the dealer is holding, and what others are doing. So you are going in blind.
Speculators often make short term investments in stocks or other assets with the idea of making a quick profit from a small price change. You can win, but it is a gamble, and the price can go up just as easily as it goes down.
Don’t get me wrong, speculating can be made into a viable strategy but it takes certain algorithms and price alerts. It can take years of experience and market analysis to become better than average at speculating the market.
A speculative trade can pan out and a good profit can be made. However in my experience, investments made speculative normally end in a loss. This is due to the risk involved with gambling on the market.
Some examples of speculating when investing could include:
- Spread betting: The act of betting whether an asset (normally stocks or forex markets) will go up or down. You don’t actually buy the asset, you just use leverage given by a broker to bet against someone else going the opposite way to you.
- Short selling: This is where you essentially borrow shares from a broker at the current market price in the hope the price will go down. Once the share price reaches your desired price you then sell the shares back to the broker at the original share price. Giving you a profit of the difference.
- Future contracts: (CFDs) This is a means for traders to speculate upon the price movement of an underlying commodity, raw material or financial instrument. The contract can either be settled in cash or in delivery of the underlying commodity in some cases. Unless hedged, gains and losses can vary widely.
- Options, puts and calls: Options provide the right to buy or sell shares of stocks at a specified price for a specified period of time. Options also trade in their own right. If you have a feeling about the direction a stock you can place a put or call option, to learn more about this form trading check out our other article What Are Options And How Do They Work
- Inverse and leveraged ETF’s: ETF’s are funds that people can buy shares of, but inverse ETF’s are the opposite to the normal funds. You can track the inverse index and use leverage to multiply the daily decrease in price. If the ETF goes down 3% and you leverage double of that, you will profit 6%. But on the contrary if the ETF goes up 3%, you will lose 6%. Also because you are using leverage, it is money that you don’t own, and you will have to pay back.
As I mentioned before, speculation is gambling, you can make a career from gambling, but inexperienced people can lose a lot of money very quickly.
What Is Investing?
Investing can mean a lot of things. Investment can be in the stock market, in a business you want to get off the ground, or in a rental property. More commonly, investing is putting money into an investment vehicle as a part of a long term strategy to build wealth.
In context, investing involves a strategy including what types of investments to make and in what volume. These investments are often some combination of stocks, bonds, and funds. A great example of this is a workplace 401(k), or a Roth IRA. Long term investments such as these are not the only examples. Some more include:
- Stock portfolios
- Rental properties
- ISA’s or IRA’s depending on what country you’re in
- Hedge funds or crowdfunding investments
- Commodities or precious metals
Investing can entail building a portfolio of more than one of these options. Usually holding multiple stocks of different companies, holding shares in a mutual fund or ETF, and having a cash account ISA.
Most importantly, investing is a calculated risk. You research, plan, and seek advice when investing. Don’t dive in head first, you can lose a lot of money if you don’t plan your investments. Stick to solid companies that have good track records.
You need to Understand The Stock Market to be completely confident in your decisions.
Key Differences Between Investing & Speculating
Most people won’t understand the difference between investing and speculating, that is why not many people get into the stock market. The stock market is not a gamble if you’re an investor, it is if you’re a speculator.
Investors have a long term time scale, whereas speculators have a short term time scale. Speculators look for quick payout that comes from volatile price movements, but investors don’t care about the short term movement, they’re in it for the years worth of gains.
The risk involved with speculating is far greater than the risk associated with investing, but that isn’t to say investing isn’t risky, especially if you’re not sure what you’re doing. This is because those who speculate tend to look for bigger, and quicker payouts. Long term investors can gain just as much profit, but it can take years.
The road to the payouts that speculators gain involves higher risk vehicles and less research materials. With riskier vehicles, that means you won’t be able to get your hands on most of the necessary ratios and financial statements investors require to make a decision.
Because investors look at the financial statements, cash flow models, and debt ratios, they have a better understanding about the company they are investing in, and they have a more educated guess on where the company is going. With the knowledge an investor has about the company they are buying, the risk is lowered but not eliminated.
The decision process
A bit of generalisation, but investors tend to take a more basic fundamental approach to decision making. They use technical analysis to base their investments on. Things like asset allocation and fundamental analysis of the investment chosen are common processes among investors.
Speculators on the other hand, look more towards general trends, new alerts, and resistance levels. Investor psychology will also come into account, if a speculator looks at an asset and in previous situations like this certain price movements occured, the speculators will assume the same will happen again. They are hoping to capitalise on these factors for a quick profit.
Not mutually exclusive
Speculating and investing are not always mutually exclusive. The same person can be both a speculator and an investor. For example, most of an investors money will be tied up in ETF’s, stocks, or retirement accounts like a Roth IRA or a 401(k). They can still take a portion of their savings and speculate with riskier vehicles, if not to make a quick profit, to diversify their portfolio.
Finally we look at patience. Being a long term investor takes more than research and putting your money away, it takes years worth of patience, waiting, and not being able to touch your money for a while. If you need money immediately you should consider checking out these 8 things to do before you start investing.
Speculators do need a bit of patience, it might be weeks or months before profits can be made, but to be an investor you need strength. Because you have a higher risk, you need strength to keep yourself in the game, you might have 5 losers in a row which can be hard to take, but waiting for that 1 big one to come in can be mentally challenging.
Investing can be very analytical and lots of us generally follow gut feelings following educated guesses. Think about it like this…
You’re taking a flight and you have 2 options:
- You can board the flight now and take off immediately.
- You need to wait another 2 hours while the pilot does his pre-flight checks.
Are you happy with the pilot guessing how much fuel is left? Or if the tyre pressure is correct?
Investing is a safe flight home with all of your pre-investing checks done. You’ve extensively researched this company and are confident your money will grow.
Speculating is having an educated guess that a company is doing alright, you haven’t check any income reports or major news surrounding the company, and you happy to weather the bumpy flight hoping you won’t lose money.
The Public View Of Investors
The broad public across the globe see’s no difference between investors and speculators. They see 2 forms of gambling that lead to very few winners and a lot of losers.
The reason people think this is because they are uninformed about the topic. If everyone knew how to successfully invest in the stock market, there would not be a market to invest in. Unfortunately the investing world is made up of winners and losers. The winners are educated and plan their futures carefully… And the losers are those who don’t take their money seriously.