Understand That Speculating Is Not Investing
Nigel is the founder of NOW Economics where he provides insights and unique perspectives on personal finance, investing, business, career and education. (www.noweconomics.com - IG @now_economics)
• Avoid losing your capital gambling speculating
• Make investments based on a company's fundamentals and within your
investment objectives and risk tolerance
• The glorification of day trading in the media
• The difference between investors and speculators
I was a speculator initially. When I first learned about investing and financial markets I came in with the wrong mindset. When I opened my first personal investment brokerage account with E*TRADE, I was filled with excitement expecting to make tons of money. For my first trades I bought shares in companies that I thought were going to rise in price in the short term, so I could sell them at their peak (highest) price for profit.
I was not making investments because I liked the company's fundamentals; I made investments based on short term speculation to make a quick buck.
What are company fundamentals?
Typically, when investors analyze a company, they look at its fundamentals: which relate to its financials, management, and other inputs that affect its stock price. You can compare this to looking under a car's bonnet or going for a health checkup.
What I should have done was read financial reports on the company, industry research and do other types of analysis, like the process you would carry out if writing an essay or dissertation/thesis at university.
When you speculate, you are typically aiming for capital gains on a short to medium term basis. Capital gains is the profit you make on an investment when you sell it for a price higher than you bought it at.
People who usually speculate move very quickly in and out of their investments, known as moving in and out of positions in finance. Since the time frame is short, they do not hold the investment long enough to receive dividends, bonuses paid out to shareholders when the company has a strong year and makes lots of profit.
Speculators attempt to predict trends in the stock market that deviate from the what is expected. They rely on technical analysis, market sentiment and events that may trigger reactions in the stock market that shift the price in their favor.
Technical Analysis is a method used to predict changes in the price of an investment based on data you collect from the financial markets. This includes studying volume (total number of shares bought and sold), trends and price patterns on charts.
Speculating is inherently riskier than investing, especially for an inexperienced investor. In my opinion, speculating should only be done when you have surplus capital (capital beyond your normal cash reserve). The amount of capital dedicated to speculative investments should only be 5% of your overall portfolio (10% if you have a stronger appetite for taking risk) because if your speculation should prove wrong, then you don't lose your entire portfolio of investments.
Many alternative investments such as commodities (i.e. gold, silver and oil), cryptocurrencies (i.e. Bitcoin) and derivatives (i.e. Futures and Options - types of financial contracts that respectively carry an obligation and right to buy a financial asset at some point in the future) tend to be speculative in nature because they do not serve as assets that actively produce earnings.
If you are a true investor your bible is "The Intelligent Investor" and your gods are Warren Buffett & Benjamin Graham who are known as the disciples of investing. In my opinion, reading "The Intelligent Investor" should be the first book any beginner investor should read.
As an investor, you should conduct thorough research of the potential investment. You may also use technical analysis to check yourself, but it is not the primary method of analysis. In your investment selection, you are focused on investments that have strong earnings (the profits a company has left after paying its staff and other expenses) potential at a good price. You may also look at the opportunities for potential growth of the company as well.
Overall, your goal is to make investments that will make a profit on the initial amount of capital you invested. You may receive returns via dividends (regular bonuses) and capital gains (profit when you sell your investment). While capital gains should not be your primary focus, they are still an added benefit and should not be ignored.
“I began to understand the difference between being an investor and a speculator”.
Seek out proper financial education
My mindset changed when I started to educate myself on finance and investments, as well as by embarking on a career in the financial services industry. I began to understand the difference between being an investor and a speculator. This is important if you want consistent growth, capital preservation (not losing the money you invested) and make investments that are suitable to your risk tolerance (the level of risk you are willing to take in terms of the investments you choose) and objectives (your investment goals).
Speculating is glorified in the media due to the excitement of making potential returns (money) to beat the market or seeing ads about the wiz kid with a Ferrari that turned $5000 into a $1,000,000 in 2 years. There is also an adrenaline rush it gives you, similar to when gambling at a casino. Speculation does have its place in investing, but should only be used in certain scenarios and within specific limits of your overall investment portfolio i.e. no more than 5% of your total portfolio (total collection of your financial assets).
The Bottom Line
Are you an investor or a speculator? Educate yourself and be sure that you are an investor. If you have a strong risk appetite and have some excess capital that you are willing to lose, then open a personal investment account with an aim to be speculative.
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