We commonly come across the term „play the stock market” more often than „invest”, right? Many of us think they mean the same thing, but how we feel about them is quite different. The truth is that the difference between them is fundamental and the „stock market game”, that is, speculation is somewhat negative. Why is it like this, and what exactly do the terms speculation and speculator mean? We’ll find out below.
Speculation and investing
Benjamin Graham – a world-famous investor and investment philosopher – mentor and teacher of Warren Buffett, drew attention to the difference between investing and speculating . He explained that the term investing means the purchase of shares related to the prospect of the company’s business and the expected increase in its value in the long term . On the other hand, the concept of speculation defined the market game based solely on the price of securities, as a result of following the trend .
These strategies are of course also distinguished by the time factor. Investing requires a lot of patience and is a long-term process as business growth usually doesn’t happen suddenly. On the other hand, in the case of speculation, the most important thing is to reflex and react quickly to what is currently observed on the stock exchange .
The relationship with the market is also completely different. Building the value of a company means working with other investors who believed in the future of a given company and decided to support it financially. Such a contribution, in turn, enables its development and profit for all who choose it. It takes the form of a dividend or an increase in the share price. Speculation, on the other hand, is a zero-sum game. It involves buying and selling instruments in order to generate profit quickly, but on the other side of these trades there is always another person who loses money.
The truth is, however, that the line between speculating and investing becomes more and more blurred every year . Speculation more and more often consists in simply buying on the falls and selling on the rises, which can be deceptively similar to investing. Additionally, this action is no longer so often perceived negatively and equated with manipulation as it was in the past. Markets have even come to appreciate its usefulness as it provides liquidity.
Speculation is now such an approach that aims to actively earn high rates of return in return for taking greater risks . The buying and selling of such an activity always takes place in the same market. The motive to speculate is therefore purely capitalist and never gives the assurance of making a profit. Its effects are greatly influenced by psychological and behavioral factors, and the effects of this trading technique are often seen in technical analysis.
Speculator and investor
As mentioned previously, a speculator is only interested in two aspects of a transaction – price and time. For him, all that matters is how the stocks are seen by the general public and how much their price may change in the short term. The speculator mainly uses technical analysis tools, i.e. all sorts of indicators that can plot certain signals or patterns on the chart that suggest entering or exiting a position.
It is completely different in the case of an investor . A person defined by this term by definition builds his portfolio based on fundamental premises and expects a profit after a longer period of time . Therefore, it carries out a thorough financial analysis based on logic, indicating a rational rate of return while minimizing the risk of losing the invested capital.
Thus, the investor perceives the stocks as fragments of the company to which he has decided to entrust his funds and feels that he is its co-owner . On the other hand, for a speculator it is only a stock ticker, he only cares for its price to go up or down on the chart in the shortest possible time . The investor also spends a lot of time getting to know the value of a given company in depth. A speculator is only interested in its current rate.
So speculators think only about their own profit , they do not care what a given company will achieve after a price change. Portfolio diversification and risk reduction, which are typical investor features, are usually alien to them. Interestingly, market liquidity depends mainly on their actions. Experts estimate that they account for 90% of all Forex trading. Thanks to them, brokerage houses and other intermediaries also earn money, of course on commissions.
Interestingly, the actions of speculators have another interesting and beneficial effect. They are able to adapt the market to changing conditions . For example, if they predict that there will soon be a problem with the availability of crude oil, they will start buying it, hoping that its price will increase significantly in the future due to its deficit. As a consequence, it actually increases, which in turn is an incentive for the market. Consumers are trying to reduce its consumption, and producers are increasing their extraction. However, when there is a real problem with its availability, the price fluctuations will be less violent, because the market will already be prepared for this phenomenon.
A bubble is a self-perpetuating process triggered by unsustainable speculation and associated with market overactivity. Consequently, after a period of sharp price increases, it leads to a sudden crash – the bursting of the bubble, resulting in huge losses for many speculators.
The most famous speculative bubbles are:
- Tulipomania, or speculation with tulip bulbs in the Netherlands in 1636-1637
- Railway Mania in the first half of the 19th century in Great Britain and the USA
- The speculative bubble in Japan 1986-1989
- Internet bubble 1995-2001