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Understanding Trading, Investing and Speculation

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

10691 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.