When it comes down to a specific trade, there are two key terms that you can use to define the trade itself, are you investing or are you speculating. In this article we will clearly define speculation and investing and the difference between the two.
When a trader is said to be investing, he is investing his money into a long term position which the risk is said to be low. This company may pay a consistent dividend, and have a proven track record of positive returns on investments. Take for example a company like Johnson & Johnson(JNJ). Since the early 1980s this company has done nothing but improve and provide investors with a solid return on their investment, while providing a consistent dividend year after year. A typical trading scenario that could consist of investments could be a buy and hold strategy, or even some high grade bonds.
When a trader is said to be making a speculative trade, he is entering a position where the risk is considered to be quite high. These companies typically are newer, and have some form of technology,drug, or promising work in the future that could succeed and drive the price of the stock way up. Take for example a medical company who is in the first stages of developing a drug that could cure or treat a severe mental or physical disorder. This drug still has to go through a series of tests before approval and there is just as good of a chance that the drug never makes it to the shelves than it succeeding. If it doesn’t, the company will probably fizzle and potentially go bankrupt. This is a perfect example of a speculative trade and traders are said to be “gambling” when they make this kind of trade. A typical trading scenario that could consist of speculative trades are possibly trading options,penny stocks, and even buying some low grade bonds that offer higher payouts, but are not guaranteed.
When you are looking to define speculation and investing, the main difference between the two can be summed up in one word, risk. It is not necessarily a bad idea to assign a certain percentage of your portfolio to speculative trades, as most of the time its not just a blind gamble, speculators realize the inherit risk is higher, but still try to do as much research as they can before executing a trade. But over the long term, the majority of your portfolio should be directed towards high grade stocks that offer very little risk albeit smaller returns.