At times, when financial headlines are dominated by meme stocks, nonfungible tokens (NFTs) and cryptocurrencies and a small army of so called investors has made millions ignoring convention and betting on assets that did not even exist a few years ago, it’s worth reminding ourselves of the difference between an investor and a speculator. What is the difference?
The Investor
Investors calculate the value of an asset. They analyse the company’s financial statements, looking at sales, earnings and expected growth rates. They examine the health of the underlying businesses and assess the company’s competitive position.
Benjamin Graham and David Dodd developed these tools in their book, Security Analysis, published back in 1934. And it’s the mainstream approach
The Speculator
Speculators simply bet on an asset because they have a hunch, like an idea, heard about it in the (social) media or see it’s gone up a lot. They believe that there will be another speculator one day who pays more for it than he did. Speculators believe they will have the discipline and foresight to get out before the price drops. But much like gambling, speculation can become addictive. More often than not, speculators blow up from throwing good money after bad.
But not all speculating is gambling. There is also smart speculation. Like traditional speculation, smart speculation makes a bet on the expectation of short-term gains. But smart speculators make their bets using a highly disciplined approach to decision making. They have a strong focus on the risks you are taking. They have stops in place and calculate bet sizes and risk reward ratios accordingly. Sometimes, like swing trading, they are the product of rigorously back-tested quantitative algorithms. These algorithms identify oversold stocks that are due for a rebound back to their primary upward trend. Unlike speculating with your gut, the algorithms help nudge the odds of a successful trade in our favour.
This is way I would rather call smart speculating trading than speculating.
Sven Franssen