Many people think that speculating and investing are the same, but the reality is that there are very significant differences between speculating in the stock market and investing in the stock market.
In this article, we will explain what it means to speculate and what it means to invest. We will also explain the main differences between these two concepts, and their main advantages and disadvantages.
What does it mean to speculate?
Speculation on the stock market consists of opening and closing trades on the stock market for a short period of time, usually during the same day. In essence, speculation seeks to buy low and sell high, gaining the differential between the purchase price and the sale price.
In speculation, we do not take into account the fundamental aspects of the company, we base the operation on the analysis of the price movement to detect entry and exit patterns.
What does it mean to invest?
Investing in the stock market consists of carrying out an exhaustive analysis on those companies that offer a greater growth potential to obtain certain profitability, buying at a price cheap enough to have a margin of safety.
To invest, it is convenient to analyze the fundamental data of the companies, which refer to profits, debt, and business strategy, in addition to taking into account other indicators such as the PER (Price Earnings Ratio).
The 3 Differences between Speculating and Investing
Although many people think that speculating and investing are very similar, the reality is that there are great differences between these two concepts. In the next section, we analyze the 3 main differences between speculation and investment.
To determine that we are making an investment, we must meet 3 criteria:
- Exhaustive analysis
- Safety margin
- Performance
We explain each of these criteria in detail below.
Exhaustive analysis
To invest in a company we must have a piece of deep knowledge about the business and understand how the company makes money. There are people who buy long-term stocks without spending time understanding the business, assessing risks, and determining whether the company is expensive or cheap.
If you spend more time choosing your new refrigerator than analyzing your own actions, you are not investing correctly, because you are putting money into a business that you probably do not understand.
Some of the points that we must analyze exhaustively when we are going to invest in a company are the following:
- Business activity
- Profit margin
- Cost structure
- Short and long term solvency
- Competence
- Market share
- Entry barriers
- Growth expectations
In essence, it is convenient to analyze everything that can influence the valuation of the company, always using the same criteria.
Safety margin
The safety margin is a term created by the renowned investor Benjamin Graham that serves to protect against losses in the face of market variation in the short and medium-term.
Calculating the intrinsic value of companies allows us to buy excellent businesses at discount prices. Thanks to this calculation, we can buy companies with a large margin of safety, which refers to the differential between the price at which the share is traded and its target value.
Thanks to the safety margin we can protect something as important as our capital. And Warren Buffett already said it in one of his famous phrases…
” The first rule is to never lose money. The second rule is not to forget the first rule. ” Warren Buffett.
Performance
Profitability is the primary objective of investing in the stock market. We invest to get a return on the savings we have in the bank without producing anything at all.
Each investor has a different risk profile, therefore the return will depend on the risk profile of each investor, and the skills they have to buy excellent deals at cheap prices.
The appropriate return depends on the risk the investor is willing to accept. Therefore, achieving a good return will depend on each investor and each investment.
Differences between Trading and Value Investing
Although it is true that investment in value is one of the most popular investment strategies due to its high returns over long periods of time, this type of investment also offers a series of disadvantages compared to trading, such as the time factor.
However, there are no studies that show that trading is more profitable in the long term than investing in stocks. The shares have appreciated 6.7% per year throughout history, while Warren Buffett has managed to obtain returns of 20% per year through value investing.
Advantages and disadvantages of trading
Let’s see then what are the main advantages and disadvantages of trading compared to investing in the stock market in the long term.
Advantages of trading
In trading, there are mainly two advantages over long-term investment.
Short term results
In trading, operations of seconds or minutes are carried out within the same day. That means you can have the money in your pocket at the end of the trading session.
If you are a profitable trader, you can generate your own daily and monthly salary thanks to the results obtained throughout your day-to-day. That is something that we do not achieve with long-term investment, where we can have great wealth, but over the years.
Invest down
In trading, it is very common to invest both up and down. That means we can make either money by “betting” that stocks will go up, or “betting” that stocks will go down.
This is done primarily through two financial products, CFDs and ETFs. Although it is true that in long-term investment these two products can also be used to invest down, the reality is that it is practically never used.
Disadvantages of trading
In trading, there are mainly three disadvantages compared to long-term investment.
commissions
One of the main disadvantages of trading is the commissions. For each sale and purchase operation that we carry out, we will have to pay a commission to our broker. In the case of trading, this is a significant cost, since throughout the day we can carry out a large number of operations.
That is why it is important to choose a good broker, to have competitive commissions that do not hurt our results because of this operating cost.
Taxation
Long-term investment has the advantage that we can pay deferred taxes until we sell the shares or investment funds. Thanks to this, until we carry out the sale operation we can maintain our positions in shares for years without paying a single euro in taxes.
In trading we buy and sell on the same day, which means that we cannot pay deferred taxes, because at the end of the day we will have closed all our operations.
Weather
Although it is true that with trading you can have practically immediate results, to achieve them you must dedicate yourself to operating several hours each day to be able to carry out winning operations.
Therefore, trading gives you short-term results but requires daily dedication to get that return. On the other hand, long-term investment requires several years to make the investment profitable, but you can have your shares on automatic pilot and review them once every three months.
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