In our blog, we write a lot about working on the stock exchange, but until now we haven’t discussed separately how investments fundamentally differ from speculation. Both types of activity are actively used on the exchange, both have their advantages, but what is the difference?
Investopedia Portal disassembled this question is in our article, and we present to your attention an adapted version of this material.
Investors and traders take on a certain amount of risk that they are trying to calculate. This is done in an attempt to make money by making transactions on the open market. And the level of risk in transactions is the key difference between investment and speculation.
In general, whenever someone spends money in anticipation of future profits, it is an investment. In this scenario, the decision to enter into a trade is usually based on some reasonable assumption made after some analysis of the probability of success.
But what if this investor decides to make a deal where the likelihood of failure is high? This will already be speculation, because here the success or failure of the operation will more depend on the case, uncontrollable external forces or events.
Basically, stock speculation is a way to make money quickly, while investments are made on the basis of more thoughtful analysis that allows you to reduce risks. But let’s talk about all this in more detail.
What is investment
Investments can take many different forms. In finance, investing means buying and selling any financial instrument in the hope of earning an income. At the same time, investors strive to ensure that the risk in their operations is average or below average. The income itself can be expressed in an increase in the price of an asset, receiving dividends or interest payments, or in a full return of capital.
Most often, this can be achieved by buying and holding an asset in a portfolio for quite a long time – it can be a year or more.
Investment example: There is a reputable, large international company. It pays dividends, and these payments are constantly increasing. The risks of investing in its stock are low. So the investor can buy them and hold them for a long time to get a satisfactory return while keeping the risk low. Also, an investor can collect a portfolio of shares of similar companies from other industries. So he will not have a very large income, but with minimal risk.
In investment, analysis and research are key factors. Investors study various assets, industries, trends in specific market segments, use fundamental and technical analysis tools to develop an investment strategy. The investor’s task is to understand what factors influence the price of shares or other financial instruments, as well as determine the best time to complete a transaction.
To make investments on the exchange, you need a brokerage account – you can open it online… Investors then gain access to hundreds of different stocks. In Russia, you can now even buy foreign shares of American companies like Apple, Google and Facebook.
What is speculation
Speculation is the act of investing money in a high-risk event in the hope of earning a higher return. At the same time, speculation on the stock exchange is incorrect to compare, for example, with casinos or sports betting. Speculators, like investors, still try to make decisions based on a certain analysis. However, in any case, the risk of speculation is always higher.
Speculators buy shares, understanding that they will not keep them in the portfolio for a long time. They can enter and exit positions frequently.
An example of a speculative trade: A trader found shares in a young gold mining company. In his opinion, the chances that the company will find a new deposit or go bankrupt in the near future are equal. The investor would have studied the company in more detail, and if he had not found more information, he would not have invested money. But speculators may believe in the company or want to participate in the current rally in the stock.
Speculative trading on the stock exchange has its own characteristics. For example, trends are very influential here. As certain market segments and companies grow, more people tend to speculatively trade the corresponding instruments. Trading volume rises, which leads to a bubble. As a result, situations can occur, such as the dot-com crash in the early 2000s.
There are several types of speculators: scalpers, day traders (you can read more about the types of traders in this our old article).
At the same time, speculators use not only stocks and standard operations with them. Futures contracts, put and call options, short sales, etc. are used.
The main difference between speculation and investment on the stock exchange is the amount of risk that the participant in the transaction is willing to take on. Investors are ready to expect not so big profits for a long time, but with little risk, while speculators are looking for maximum profits in a short time and are ready to take higher risk.
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