As the world of retail trading and investing is changing rapidly, and particularly since the beginning of the pandemic, many novice investors find themselves confused and more vulnerable than ever before, mistaking investing for financial speculation and the other way around. They just don’t recognize the difference. But, what really is the difference between investing and speculating?
The Rise of Retail Traders
Before we get to the explanation how investing and speculating differ, it’s important to understand the environmental circumstances that have led to the “rise of newly empowered retail traders” (as per Deloitte).
High Volatility Emerged
The pandemic crash in March 2020 that led to one of the biggest rallies in stock market history. And then there were more “get rich” opportunities than ever before.
These so-called investing opportunities lured in many retail traders to partake in the party. Buying stocks became one of the most popular social discussions again, and almost everyone was doing it. Hence, some of the new market participants were brand new at DIY trading.
Some stocks that have received “good reputation” amongst retail traders were soaring in value in spite of very little support from institutional investors. This led to even MORE attention in mainstream media, luring in the hordes of inexperienced traders.
It was particularly evident in the GME (GameStop) case. This is where retail traders from Reddit’s WallStreetBets forum took on the big funds that were shorting the stock. GME stock went up approximately 100x in value from $3 to $30o. Now it sits at around $100, making many speculators, particularly ones using high leverage. And they’re more wealthy than they imagined they would be.
So what happened a few years back? Why are there so many retail traders now?
There are many reasons (and this is lead to the investing and speculating store we’re exploring today):
1) More time at home
During lockdowns and thereafter, people stayed home. Even nowadays, 2 years into the pandemic, there is a substantial amount of people who work from home and this may become the new normal.
And, when you are at home, whether on a furlough, sick, in isolation, or even furlough your full-time work, you have more time to trade than you did before.
2) The demise of robo-advisors and other forms of passive investing
In 2018 and 2019 one of the biggest buzzwords in the world of Fintech were robo-advisors. Robo advisors were a much cheaper alternative to managed passive investments than flesh and blood financial advisors.
But, in 2020, robos performed poorly and a lot of their customers withdrew their funds to become do-it-yourself investors (or alas, speculators focused on playing the stock market by buying stocks on leverage and/or trading options).
3) Soaring inflation
As inflation rears its head in the U.S and globally breaking 30 years records, the main mantra advertised is that if you have cash money sitting aside, you’re losing money.
In essence, unless your funds are tied to a vehicle generating higher percentage than inflation, you lose. That drove a lot of people to invest money they meant to keep in cash.
4) Better trading conditions
Online stock buying has been around for a long period now, but the fees has been reduced significantly over the past few years.
In the U.S, companies like Robinhood allowed smaller traders buy partial stocks, and at the same time made stock buying absolutely free.
If prior to Robinhood the rule of thumb was to make as few changes as possible in your portfolio due to the costs of each trade, now investors (or, better put, speculators) are inclined to make as many changes as they would like. They might even trade on a daily basis, and with literally no cost.
And it’s not only a U.S thing – buying stocks in Canada for cheap is made possible with no less than 6 brokers who offer full or partial a “free stock trading” policy.
Retail Trading is up…Now what?
All of the above conditions have changed the stock market forever. Better trading conditions fueled by a pandemic leaving people bored at home proved to be explosive. Swings are bigger, and so is the risk to gain or lose.
So now we get to the core question…
What’s the difference between investing and speculating?
Both traders and investors are buying and selling stocks based on who they think will provide the best return, but they differ in the following:
Financial speculators tend to go “all in”
What’s the main difference between investing and speculating?
It’s right here.
Speculators tend to wager large amounts of money on their grand theory for the markets.
Investors, on the other hand, tend to make smaller bets with a portion of their portfolio. And, at the same time they keep most of their equity tied to broad indices and bonds (they will never go all in on one stock or even one sector). Investors know a grand key in investing success is diversification.
Speculators love to move on hot tips or short-term theories. Investors look at the medium and long term. If the short term gain looks good, but the long-term outcome is likely a loss, they’ll stay away from these plays.
Financial speculators tend to be overleveraged through margins or options
What’s yet another difference between investing and speculating? Speculators are often over-confident in their abilities and even take out loans for their investments.
Investors would rarely behave this way. They focus on their earnings and only invest with excess money, not future money that they don’t yet have.
Financial speculators tend to chase the news
Speculators think the talking heads on TV and blogs actually know what they’re talking about. And they act based on what they hear.
Investors, being longer-term thinkers, will modify their long-term investments slightly from time to time. They will never make drastic moves in the market like speculators often do.
The Difference Between Investing and Speculating – Which Are You?
If you are investing to get rich as quickly as possible, rather than hit a certain benchmark as per your risk appetite (not everyone tries to beat the broad index; many investors would be happy with a much lesser result if their perceived risk is low), then you are nothing more than a financial speculator or financial gambler.
Don’t get me wrong, there are profitable short term traders out there, but hardly anyone who is a novice at this and has gotten to trading through the circumstances described above.
If you’re only thinking for the short term, you’re speculating. If you’re a long term thinker with long term plays, you’re an investor and will likely do well financially in life.
My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.