Friday, July 17, 2009

The Difference Between an Investor And a Speculator

The Difference Between an Investor And a Speculator

Investors and Speculators are 2 different players in the stock market. When people invest in the stock market, they are doing it as one of two people: either as an investor or a speculator. There is no business without risk. Hence the risk of investing in the stock market is high. This high risk was exhibited in the recent global stock market meltdown where both the so called investors and speculators were not spared by continuous depreciation in the value of their stock investments. The stock market over the years is said to have the potential of returning higher returns in comparison to other forms of investment. Arguably, the returns one gets from investing in the stock market as an Investor or a Speculator depends on the individual, i.e. it depends on whether you are an Investor or a Speculator. The recent meltdown left no one in doubt as to who is an Investor and who is a Speculator.

Speculators - They are those that buy securities without holding them for a long period. They invest in stocks not for purpose of receiving dividends. They are short term players in the market. They study and predict the market so s to know the best time to buy or sell stocks. They sell their shares because they anticipate the prices are peaking or to realize a profit. To be a successful speculator is as tasking as living and breathing the market you want to speculate in. Often, they will buy shares in a company because they are "in play" (which is another way of saying a stock is experiencing higher than normal volume and its shares may be accumulated or sold by institutions). They buy stock not on the basis of careful analysis, but on the chance it will rise from any cause other than a recognition of its underlying fundamentals. Speculation can be profitable in the short term (especially during bull markets), it very rarely provides a lifetime of sustainable income or returns. It should be left only to those who can afford to lose everything they are putting up for stake.

In the book “The Intelligent Investor” by Mr. Benjamin Graham, he said “The most realistic distinction between the Investor and a Speculator is found in their attitude toward stock market movements. The Speculator’s primary interest lies in anticipating and profiting from market fluctuations. The Investor’s primary interest lies in acquiring and holding suitable securities at suitable prices. Market movements are important to him in a practical sense, because they alternately create low price levels at which they certainly should refrain from buying and probably would be wise to sell”.

Investors – They are people that buy stocks and hold them for a longer period of time. They are long-term players in the market. They hold on to their stocks and receive dividends at the end of the year. If they invest in bonds, they wait until the maturity period of the bond. They maintain their long-term objective for investing in the market. Usually. they carefully analyses a company, decides exactly what it is worth, and will not buy the stock unless it is trading at a substantial discount to its intrinsic value. They make their investment decisions based on factual data and do not allow their emotions to get involved.

The activities of Speculators and Investors affect stock prices. The speculator will drive prices to extremes, while the investor (who generally sells when the speculator buys and buys when the speculator sells) evens out the market, so over the long run, stock prices reflect the underlying value of the companies. If everyone who bought common stocks were an investor, the market as a whole would behave far more rationally than it does. Stocks would be bought and sold based on the value of the business. Wild price fluctuations would occur far less frequently because as soon as a security appeared to be undervalued, investors would buy it, driving the price up to more reasonable levels. When a company became overpriced, it would promptly be sold. Speculators on the other hand, are the ones who help create the volatility the value investor loves. Since they buy securities based sometimes on little more than a whim, they are apt to sell for the same reason. This leads to stocks becoming dramatically overvalued when everyone is interested and unjustifiably undervalued when they fall out of vogue. This manic-depressive behavior creates the opportunity for us to pick up companies that are selling for far less than they are worth.

This leads to a fundamental belief among value investors that although the stock market may, in the short-term, wildly depart from the fundamentals of a business, in the long-run the fundamentals are all that matter. This is the basis behind the famous Ben Graham quote "In the short-term the market is a voting machine, in the long-term, a weighing one." Sadly, some reject this basic principle of the stock market.

Whether one is an Investor or a Speculator, it is advisable to conduct both technical and fundamental analysis of the company being invested in. It is dangerous and risky to invest in a company based on sentiments. Remember to invest what you can lose in case the unexpected happens.

In conclusion, however, the story of a man who had waited patiently for years expecting to win a lottery, came to my mind. He was waiting to win a lottery without buying a ticket to play the lottery until someone asked him “have you played?” You might be waiting to reap bountifully from the stock market or other investments, but have you started investing? Remember that you can if you think you can.

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