Invest, Trade or Speculate?

What exactly is the difference between the terms trading, investing and speculating? You have no doubt come upon these terms countless times in your readings without having a clear understanding of their distinction. Unfortunately, there are no hard and fast definitions, but I can at least give you a feel for these terms at an abstract level. It's easiest to examine the differences between each of these ideas separately.

Investing and Trading

The difference between investing and trading, simplistically, is that investing is long-term whereas trading is short-term. A trader will move quickly in and out of stock, picking up a few points here and there whereas an investor is in for the long haul and is more interested in consistent growth in the long term. It's important to understand this simple distinction and keep the two separate; stocks that you trade and stocks in which you invest should be treated completely differently. When you are trading, you are only interested in the money, so to speak, not in the stock itself. This means that when the stock value is dropping you get rid of it; if it rises you sell it (at the right time) and re-invest your profits.

Investing and Speculating

The difference between investment and speculation is considered by some to be an extremely important distinction. Investor/Writer Benjamin Graham, for example, chose “Investment versus Speculation” as the title for the first chapter of his extremely popular book, “The Intelligent Investor” (1985). The reason this distinction is so important is that investors often get themselves into trouble by speculating when they think they're investing. When you invest, you are accepting the average rate of return that the current markets are paying; when you speculate, you're attempting to beat that return by somehow being smarter than other investors or acquiring knowledge that others lack.

Speculating and Trading

Okay, so what's the difference between speculating and trading? Again, it isn't written in stone, but when you're trading you're still not necessarily trying to “beat the market”; an intelligent trader knows that he can only expect a certain return on his dealings. The two ideas aren't actually mutually exclusive at all; there are plenty of speculative traders, but this term would only be used to distinguish from speculative investors. The difference between a speculative trader and a speculative investor is the same as the difference between a trader and an investor; one must merely ask the question: Will the outcome of the speculation yield long-term gains, or only a short-term spike in the stock value?

Now that we understand, to some extent, the difference between speculating, trading and investing, we should also be able to realize that a person can do all three things at the same time. Just make sure you understand the difference and treat your dealings appropriately. Before you buy, classify what you are doing under the appropriate heading; what are your goals in buying this stock? As mentioned, you should keep your trading and investing portfolios separate but also have it clear in your mind whether you are speculating or not, consider flagging each stock as speculative or non-speculative; if you think you have inside information on a stock, then you are speculating, but otherwise you should be expecting average market returns.

Next: What markets to trade - Stocks, Options or Futures?