When it comes to financial trading, what’s your particular style? Some people like to craft relatively conservative portfolios comprised of several stable long-term investments and primarily conventional assets. Traders exploring more speculative assets like cryptocurrency, meanwhile, might favor big players such as Bitcoin and Ethereum. They may also back specialized altcoins like the privacy-focused XMR, which can only be traded from a highly secure and dedicated Monero wallet.
Whatever your preferences, it’s clear that there’s a vast variety of ways to trade assets in the attempt to turn a profit. At the outset, “investing” and “speculating” seem like similar financial activities and may even sometimes be used synonymously during discussions of trading. On a basic level, they both involve the attempt to profit off of particular transactions the trader has made in a certain market. Both methods of trading also involve a measure of calculated risk.
The level of risk attached to traders’ transactions, however, is an important factor that differentiates investment from speculation. In this feature, we’ll explore this risk and other major differences between these two strategies before weighing up the merits of each.
Understanding Investment
Broadly put, an investment is an asset that’s acquired in the hope that it will generate income or grow in value in the future, usually over a lengthy time horizon. Operationally, investing most often refers to the buying and selling of assets such as bonds, stocks, mutual funds, exchange-traded funds (ETFs), and others. To guarantee a satisfactory return on their initial capital, investors are normally only willing to take on a below-average to an average amount of risk.
The investment process typically involves extensive amounts of research and analysis. Traders and financial advisors look at different types of assets, sectors, and current market trends to identify fruitful investment opportunities. Knowledge of the macroeconomic and microeconomic factors that affect the value of particular assets is also necessary to determine an optimal investment strategy. Lastly, effective portfolio design demands that investors diversify their assets to lower risk and boost overall profitability.
In this day and age, there are many convenient, efficient, and often lucrative ways for investors to trade assets. Brokerage firms, for instance, allow investors to open accounts, view a variety of securities, and place buying and selling orders through the firm. Investors receive full ownership of their assets and any income these assets generate, while the firm takes a commission for any trades it facilitates on the investor’s behalf.
Understanding Speculation
In contrast to traditional investment, speculation refers to a usually short-term financial transaction that promises significant gains but also equally substantial risk. Speculative trading is frequently characterized by volatile price swings, highly changeable market conditions, and above-average chances of failure.
While speculating has been likened to gambling, it is not exactly the same. While both activities technically involve taking calculated risks and some level of skill, most who participate in gambling do so for the thrill of it. On the other hand, speculators are more in it for the potential gains. As such, they often do as much as they can to up their chances of turning a profit, even if the risk of failure is high. Rather than leaving everything up to chance, serious speculators conduct significant research to make the most educated possible decisions.
As a concrete example, cryptocurrencies are still widely thought of as speculative assets by financial experts, even given their rapid spike in popularity over the last few years. The values of even the most well-established coins remain highly volatile and can appreciate or depreciate rapidly in just one day. While more traditional investors would shy away from trading such risky assets, crypto enthusiasts regularly monitor their chosen coins and the market at large for opportunities to buy low and sell high.
Speculative trading can take many forms. One of the most common is day trading, which is characterized by quick, frequent buying and selling. True to their name, traders usually hold their positions for just one day and close when the current trading session completes. Swing traders, meanwhile, may wait to capitalize on gains for several weeks. They use that time to determine the direction of a particular asset’s price, take a position, and generate a profit.
Investing vs. Speculating: Key Differences
Investing and speculating can be differentiated by the following important criteria, among others:
Decision-Making Criteria
The decision to invest is generally based on a trader’s knowledge of business fundamentals and on the conviction that such fundamentals will enable them to turn a profit. Meanwhile, speculation has little to no regard for the fundamentals and hinges most of its convictions on the movement of an asset’s price. Speculators aim to predict price direction by studying market psychology and technical charts and tend to set store by their individual opinion of how an asset may appreciate or depreciate.
Level of Risk
As previously mentioned, the level of risk taken is a major differentiator between investing and speculating. Some even say it’s the primary difference between the two methods. Investments demand the safety of principal and require satisfactory returns in proportion to the risk taken, which means that most investment operations operate at low to moderate risk levels only.
But what of more aggressive types of investments? Generally speaking, even the most aggressive traditional investments are considered safer than speculative ones. This is because most traditional investments are currently better known to the world, so the phenomena behind gains and losses are better documented.
Speculation, on the other hand, welcomes a higher risk factor. Speculators bank on the possibility that their investments, which typically do not have traditional financial value ascribed to them, will eventually become highly sought-after assets in the future. This presents speculators with a higher chance of total loss on the assumption that much larger than average gains are also possible.
Time Horizon
Investing and speculating differ in terms of their time horizon, or the presumed length of time that a trader intends to hold an asset. Investing is usually a long-term endeavor, often spanning longer than a year, whereas speculative operations typically close in under a year. Some speculative traders even make and close bets within a single day.
While both investors and speculators aim to earn profits off their assets, their methods, underlying motivation, and attitudes differ substantially. Which financial strategy is right for you will ultimately depend on your long-term objectives, the resources available to you, and your own risk tolerance.
