Healthy Finances by Infinite Ideas

Author:Infinite Ideas
Language: eng
Format: epub
Publisher: Infinite Ideas Ltd
Published: 2012-06-25T00:00:00+00:00

23

Speculation

Speculation is an effort, probably unsuccessful, to turn a little money into a lot.

Much is made of the difference between investment (a ‘sensible’ activity) and speculation (a ‘risky’ activity) but, as Fred Schwed points out, it is not always easy to tell the difference between the two. Plenty of cautious investors have lost money in what they thought were safe investments, sometimes through skulduggery but more often because the investments turned out not to be quite as safe as all the experts thought they were. So you might say that investments that were generally thought to be safe but actually resulted in losses should be classed in the speculative category. This doesn’t help us much though, because as investors we need a definition that can help us make decisions about the future; just saying that all past loss-makers were speculative doesn’t tell us anything useful.

To understand speculation, you need to understand human nature. It is very natural and human to get excited and confident when you have made some money easily and it looks as if you are going to make a lot more even more easily – that’s how the psychology of booms works, when even normally cautious people start plunging into riskier and riskier investments. But real speculators, the people who are just naturally inclined to take large risks, are different: they will speculate whatever the market is doing, whether it is going up, down or sideways.

Beginners at stock market investment often try their hands at speculation. This is unwise, because they don’t understand the market very well. Typically, beginners think, ‘If I can pick a few winning shares, I can sell out when the price goes up and make a quick profit.’ The odds are against them, for two main reasons. First, there is very good evidence that no-one, even the experts, is much good at picking winning shares consistently. There are famous exceptions to this rule, such as Warren Buffett, but, basically, they improve their odds using methods that are not available to the ordinary investor. Second, most beginner investors have no idea how to evaluate a particular company or to assess the risks of a given investment.

Is speculation always foolish, and will it always end in tears? Not necessarily. For example, if you have better knowledge than others about a particular investment or situation, you may judge that it is less risky than other people realise. As a speculator, you look for opportunities where there is a high reward to risk ratio; if you can find them, you’ll make money. In the major stock markets, however, such opportunities are rare – to find them, you’ll have to go further afield, to developing countries or outside the stock market altogether.

Defining idea

There are two times in a man’s life when he should not speculate: when he can’t afford it, and when he can.

Mark Twain

Here’s an idea for you

The stock market is a game that is designed to foil speculation. If you really want to take large risks

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