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Understanding Trading, Investing and Speculation

In this episode, we will help you understand the difference between Trading, Investing and Speculation.

1817 views  31 Oct 2017

Trading, Investing and Speculation

People adopt different strategies to make money in the stock market. Stock Trading, Investing and Speculation are the different methods you can apply in order to create wealth. What you need to keep in mind is that a lot depends on the investing style of an individual and his or her capacity to take risks.

You may choose to either invest long-term or trade relatively short-term on the basis of whether you are a conservative, moderate or aggressive investor. The three modes differ in terms of the core objectives, individual preferences, the measure of risks involved and the time period it takes to get returns.

What is Investing?

The main objective of investing is to create wealth in long-term and it is driven by the fundamental position of company/sector. As an investor, you need to approach investing with a very logical and analytical mindset. And you would end up evaluating a stock, its fundamentals, and the stock’s industry and then juxtapose it with the general economy to gauge the worthiness of an investment.

Hence, investing assesses the fundamentals – understandably the long-term drivers of stock prices. If you are a long-term investor, you should refrain from giving knee-jerk reactions to bullish or bearish phases.

For an investor perhaps the biggest advantage is that there is no tax on investment gains beyond 1 year. Another good thing about investing is that it involves fewer transaction costs. On the other hand, a stock can plummet due to market conditions or have periods of flat performance and in this scenario an investor has to tolerate the correction.

Types of Investing Style-

Top Down approach and Bottom Up approach Top Down approach - Investors first look at economy then industry/sector and after that they select companies.
Bottom Up approach - Investors select strong companies with good outlook regardless of industry and economy.
Based on Market cap Some investors specifically invest only in blue chip companies, mid-cap companies or small-cap companies.
Active Investing and Passive Investing Active Investing - Investors actively manage their portfolio to beat the market.
Passive Investing - Investors create a replica portfolio of a index stocks.
Value Investing and Growth Investing Value Investing - Investors look for companies that are undervalued in the market.
Growth Investing - Investors look for companies that offer higher earnings growth.
Growth at Reasonable Price (GARP) Companies with consistent above industry earning growth at reasonable valuation.

What is Trading?

Trading involves more proactive participation from an individual. This style is much more dynamic and if you are a trader, you may chose to buy or sell stocks immediately to book profits or dodge losses. This style is usually based on the analysis of the price or volume of a stock and is driven by technical and derivatives studies.

Thus, trading involves evaluating stocks that have the ability to move quickly. A seasoned trader would want to make quick money, and he is likely to capitalize on crowd psychology and market movements.

From a trader’s point of view, the fundamentals are not the primary factor to induce buy or sell decisions as they believe in Efficient Market Hypothesis which means all the information is already discounted in the stock price. However, because of its very nature, trading involves more costs due to frequent commissions and short-term taxable gains.

Momentum Trading

What is Speculation?

Speculating can be characterized as gambling in a sector or a stock. This method does not involve any analysis or assessment and is a high risk, high return option. Arguably, trading can be understood as short-term speculating because the trader makes an educated guess about something that’s not definite or measured.

Taxation in Investing, Trading and Speculation

In terms of the payable tax, short-term gain attracts a flat 15% tax, while the tax liability for Intraday gains (speculative income) and F&O gains (non-speculative gains) depends on the on the tax slab of the investor.

What is the difference between Trading, Investing and Speculation?

All the three methods are employed to make money in the stock market. However, there is a marked difference between the three methods. Investing implies holding a position in a stock for long-term, and the primary objective of this mode is long term wealth creation.

Investing is a strategy which is well thought of in advance and does not involve abrupt reactions to sudden market changes. Investing is based on fundamental analysis and measured risk to get long term gains.

On the other hand, speculation is understood as financial gambling where buying and selling of stocks is not based on in-depth research or analysis. When a trader speculates, he is more likely to be swayed by popular market sentiment. In this mode, the risk is high, but so is the possibility of earning profits.

Speaker's Profile

Aniruddha Dange

Aniruddha Dange

Mr Aniruddha Dange is the Chief Strategy Officer at IIFL group with focus on process optimization and digitization. Previously, he served as the Head of Research, Institutional Equities at India Infoline Ltd. Mr. Dange was also employed at RBS Research, CLSA Limited and ICICI Securities Ltd. Mr Dange is an Alumnus of IIT Bombay and IIM Kolkata and has over two decades of experience.

Ask an Expert

FAQs

What is Trading?

Trading in stocks involves buying and selling of stocks in a short period of time. Analysis with respect to prices of stocks against their volume is done by experts or research advisories such as IIFL to make the calls. As analysis is done, the investment risk is measured.

What is Investing?

Investing in stocks is a strategy that aims for long term wealth creation. In this, stocks are invested for a longer period of time based on the fundamental analysis done by the investors or research analysts. An investor usually takes a long term position based on fundamental analysis in a company or a sector. Period is more than 1 day to 6 months, or years, whichever is the strategy of the investor. There is no tax on gains beyond 1 year of investment period.

What is Speculation?

Speculation of stocks or stock speculation is utter gamble. In this type of trading, the speculator may take buy or sell position based on his gut feeling or the popular sentiment of the market. Since no analysis or studies are done, the risk involved is extremely high. Speculation is done in F&O trading and Margin trading segments.

What is the difference between Trading, Investing and Speculation?

There are three ways of earning money through stock market - Investing, Trading, and Speculation. Stock investing involves implementing a strategy that tends to hold stocks for a longer period of times. It is based on fundamental analysis and measured risk to get long term gains.

Stock Trading involves implementing a strategy that includes buying and selling stocks in a short period of time. As the term is short, analysis, especially technical analysis, is necessary and the underlying risk is high.

Stock Speculation involves buying and selling of stocks based on gut feeling or popular market sentiment. The risk is extreme as it is not based on any study, but the gains can be substantial if lucky.

How do I understand that I am Trading or Investing?

Investing and Trading are two very different ways of making financial gains in the stock market. While investing is done with positions that are taking for long terms, generally 1 to 3 or 5 years, trading is done in short term. If you are doing day trading, BTST or short term calls lasting for a week or month, you are actually doing Stock Trading. Investing is done for long term wealth creation.

How to do Stock Market Speculation?

Stock Speculation is a risk practice similar to that of gambling. There are no studies involved as such in taking the position in the market. The prices of stocks are affected by a variety of variables.

What to keep in mind while Trading or Investing?

Whether you are investing or trading, you should be wary about the risk. Always do analysis and then take decision on the positions to trade. Never go by gut feeling or market sentiment, as they carry too much risk. Use the concept of Stop Loss to minimize losses. Learn from your mistakes and trade professionally, without allowing your emotions to take over your calls. Trade only that amount which you can afford, do not over-leverage.

How do stock prices fall and rise?

There are several market forces that influence the price of stocks. If there are more people who are willing to buy the stocks, then the price will rise, and vice-versa. Another important factor influencing the prices of stocks is earnings per shares. These earnings change the sentiment of market towards the stock.

To create wealth, should I Invest or Trade? (IIFL Research can guide you)

Creation of wealth is a long term process. Though trading may give good returns in short time, it is not an ideal method as the risk involved is high. Capital appreciation is achieved by taking positions in the stocks for a longer period of time. That’s why it is recommended to invest.

To invest, one should do fundamental analysis by themselves or take help of experts. IIFL Research team generates several reports that are helpful for layman investors to make profitable gains in the long run.

In terms of tax deduction, how is trading different from Investing and Speculation?

As per Section 43(5) of the Income Tax Act, 1961, intra-day trading shall be considered as speculation business transactions and the income there from would be either speculation gains or speculation losses. Income from speculation gains is taxed at the normal rates. Investing on the other hand is done for long term. The tax rate is 15% if the holding period is less than 1 year. Day Trading is counted as Speculation and is levied higher taxes.

Where can I learn about Speculation and day Trading?

Speculation is similar to gambling, you need not require any market expertise. Just simple knowledge of trading, understanding of basic terminologies of the market, and zeal to trade is enough for speculation. Day trading on the other hand involves taking measured risks by doing analysis. You may learn about Day Trading from online websites, books, forums, and other digital media. As there is no fixed strategy, the learning is a continuous process.