A common question I am asked a lot: ‘aren’t all market players speculators?’ And my answer is invariably: ‘NO!’ And then I reply: ‘Are all footballers defenders?’ People look baffled and do not understand what I am trying to say.
Recently, after re-reading ‘The Intelligent Investor’ by Benjamin Graham, chapter one caught my eye and made me wonder how many people truly understand the subtle difference between investing and speculating.
Sometimes, I tend to confuse the two notions as well, especially coming from a futures trading background. Or let’s say from a futures speculating background.
The subtle difference between investing and speculating.
Graham defines an investment as: ‘an operation in which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting this requirements are speculative‘.
An investment to be consider as such, does not need only an adequate return, but, prior to action, needs analysis and also safety of principal. For the return, Graham doesn’t expect stellar results, but adequate, because he understood that in the markets safety should bring steady returns, not spectacular.
If investment is defined as such, what is speculation? He intelligently defines speculation as an operation not meeting the three objectives of an investment. We can argue that speculation is a poor investment.
Let’s deal with speculation first. Speculation can be considered every method that deals only with the price of the security. The main argument of speculation, either short term or long term speculation, is that you should buy because it went up and you should sell because it went down.
The main reason for speculation is that the market should behave in the future as it did in the past. The only argument for putting money on the line is the price movement.
With this thinking, a lot of trading techniques emerged, from technical trading to volume trading and from trend following systems to mathematical systems. Some of them may offer good results for a period of time, but in the long run all systems fail. Also, the success rate of this systems is very low, sometimes not rising above 5 percent.
The main reason for speculating for a profit, i.e. the price movement prediction, is also the main issue of it. Let’s think, what is a stock? A stock is a piece of a company, a part of a business entity. So what drives the value and the price of that stock? Isn’t the underlying company? Of course, in the short term, the stock price could be influenced by market psychology, or head-line risks, but in the long run, the stock will always follow and align with the business that is part of.
Have you met Ted?
Now let’s meet Ted. Ted is looking to buy an used sports car, he had been browsing the Internet for a few days and he came across a 2001 Ferrari Modena 360, he likes it and buys it right away, asking for it to be delivered to his home. Now wait a minute, no test drive nor engine or history check? Who is/are the previous owner/s?
By now you think that Ted is stupid, right? Who will do something like this? Let me tell you who does something like this: everyday speculators in the market. Professionals and amateurs alike who throw money on purely beautiful price action, without checking what is under the bonnet. Don’t be like Ted!
What you need to do is to look at the market as a mechanism where you can invest in the underlying companies that are sitting behind a stock price. Be like Warren Buffett who is judging an investment by the business done by the company. He sees the opportunity in the business of that company, not in the stock price of that company.
The reason for investing
One of the main characteristics of an investment is the reason for doing it, which is never the actual stock price and its behavior, but the underlying company, the enterprise and people behind the stock. For this Warren Buffett says that when looking to invest, try to consider companies who will make you comfortable being invested in them if the stock market closes for the next five years.
Every person that ever speculated or invested in the market knows that success comes not from overnight spectacular price movement, but from consistent results or steady returns.
Everybody agrees on the consistency factor. If you are looking to be in the market for the long run, why not invest the right way, the time tested, value approach, that made certain investors some of the richest men in the word.
Why try to be like Ted, a headless chicken, why not try to be like Warren Buffett and check under the bonnet the business sitting behind the stock price?
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