|Speculation and speculators are four-letter words on both Wall Street and Main Street. Last year, speculators were accused of being behind the spike in oil prices, which resulted in skyrocketing gas costs. Back in 1992, George Soros, one of the most successful speculators around, was accused of being the spark that forced the British to devalue their pound sterling when he sold short $10 billion worth of British pounds, earning roughly $1 billion on that trade alone. |
On the flip side, you have investors. Nothing bad is ever said about an investor. The poster boy for all investors is Warren Buffett. Not only that, everyone new to stock trading is encouraged to be an investor. So what is the reason for the disparity between an investor and a speculator? Is it possible that an ordinary average person can wear both hats and still be successful?
THE INVESTORS’ CASE
To put it simply, an investor is anyone who purchases a stock with the intent of owning a piece of a business. Investors will place a value on a stock and buy that stock at that price. They endeavor not to overpay for a stock because this will decrease their earning return. Investors will practice anywhere from simple to complex fundamental analysis in hopes of finding an overlooked but undervalued business. All of their investments are focused on long-term price appreciation.
Investors seek to purchase undervalued securities: companies that are healthy and ready to grow but those that Wall Street is currently overlooking. Investors will sell or scale back their positions on stocks that they consider overvalued. Many investors will usually be buying stocks that are not involved in a current market trend. Value is most important, and the stock’s current price will be the most important factor in determining if that stock is a worthy investment.
Investors will hold onto a stock and buy more of that stock during a market correction. They will not worry about a company’s earnings in a particular quarter. Instead, they look at the business and the economy as a whole in order to help determine if their investment is still sound. Investors usually do not have a price target in mind. Instead, investors sell when the company is no longer as financially sound as when they first invested. Market timing and price points do worry investors. An investor does not want to overpay or chase a stock.
Usually, investors will not be using stock charts. Instead, they are interested in the company’s current and future earnings. They are interested in the health of the sector the company is in. An investor’s philosophy is, “You’re buying a company, not a stock.” That means you understand how the company works and how it will continue to work. Investors are willing to stockpile cash or place their money in bonds when they can find no current value in the market.
|Characteristics of investors: |
- They must be willing to buy out-of-favor companies.
- They will add to their current positions on a stock that is going down if they believe the investment is still sound.
- They can accept losses and hold on for future profits.
- No specific price target or time frame is used to judge when to sell a stock.
- Investors will always understand the underlying business of the stock they are buying.
- Long-term investments will not make the investor worry about his or her portfolio on a daily basis.
- Investors must buy fundamentally sound companies that should appreciate in the future.
- They must look at a company’s fundamentals and allow an investor to remove the emotional side of investing.
- Reading and understanding a balance sheet can be a difficult and time-consuming practice.
- Biggest hurdle for any investor is setting a price point that makes the stock an attractive investment.
- If everyone were an investor, the markets would not have the same price moves, nor would the market have the same liquidity.
The speculator is simply a professional or amateur market participant looking to make big profits by taking calculated risks. The gap between the good and bad speculators is a large one. Speculators will make quick decisions when necessary. They will use any tool, technical or fundamental, or a blend of both to assist in their decision-making process. Speculators take on risk in the hope that the profit will be large. Speculators are willing to buy stocks without knowing the underlying business. Speculators can and will add liquidity and volatility to any market.
|Characteristics of speculators: |
- They will change their mind on a stock quickly.
- They will know ahead of time when they will be selling before they even enter a trade.
- They are willing to accept small losses as part of the game.
- They will buy or sell short in order to make money.
- They will use technical analysis as well as fundamental analysis in their trading decisions.
- They will add liquidity to the market. In certain markets it is critical that someone is willing to take on risk.
- They will buy and sell quickly. They will change direction a number of times during a trading day.
- They will be willing to go short as easily as go long.
- They will be willing to take a chance. Speculators are willing to buy shares of startup companies, small companies, and companies in financial trouble.
- Orderly markets seem to disappear when a lot of speculators are trading the same stock at the same time.
- Speculation alone can drive a stock price or market all by themselves.
- Rampant speculation can lead to bubbles. Bubbles always burst. The smart and prudent investor does not get caught up in bubbles. Bubbles are strictly the arena of the speculators, the gamblers, and those investors who do not know what they are doing.
INVESTOR AND SPECULATOR
How can an investor add speculation into his or her portfolio? More important, should they? There are many investors who would like to add some speculation to their portfolios. There are a few key points to remember before you start speculating. Here are a few ways to sprinkle some speculation spice into your portfolio:
- Avoid mixing speculation stocks and investment stocks. If possible, open another brokerage account.
- Never reclassify a purchase after it has been made. A stock bought as speculation that has not gone your way cannot turn into an investment. This defeats the purpose.
- Speculating is not taking a gamble in the hopes that something may happen. You speculate based upon short-term criteria being met. You do not speculate simply for the thrill of it. Remember, speculators take calculated risks.
- Make sure you can afford it. Depending upon your experience, you should limit the amount of capital you allow yourself to speculate with. You do not want to keep throwing good money after bad. If you have been losing money speculating, you need to figure out why your speculation plays are not working before you dump more money into that portion of your portfolio.
- Speculation should compliment your investment portfolio. Keep the speculation portion of your portfolio limited to an amount you are comfortable with. If you are having trouble sleeping at night, you need to cut back or cut out your speculation.
- Becoming a good speculator takes time. You cannot expect to become a good investor overnight, nor should you expect to become a successful speculator right away. Both require patience and practice.
- Know your exit. Be prepared to take a loss if you are wrong. This is the hardest part for most investors.