Speculation vs Investing
Many are looking for foolproof guide to make money from investment. The truth is “if you want to make money, you need to buy investment when it is undervalued so that you make money on the day you buy it!”
It sounds simple in theory but it is never easy in practice. This truth is not invented recently but it has been around for many years. It works. What makes it does not work is the human interaction. People let their emotions get in the way. People are scared when the market is down and they want to buy the investment when they see the investment is surely going up and they buy it too late.
How to make money? Both speculation and investment can make money.
- Speculation: we buy when the market is high and we sell when the market is higher. This is a bigger fool game. When we buy things that are overvalued (which is not a rational act), we are hoping (speculating) that there will be people who are more emotional than us to buy things much more expensive. We hence get the profit when the market moves up even higher.
- Investment: we buy when the market is undervalued, and we believe the market will go back to its true value at the end which we can make profit out of it. I shall touch on few ways how an investment is being valued to determine whether it is under or over valued in the next article.
Looking at the above, which one do you think has the better chance of success? Yes! It will be investment. When you know the way to determine the value of the investment, it will be then easier to determine the buying point. The harder part will be to handle the emotion. It is natural for human to feel scared when the market is moving down (dare not buy) and too excited when the market is moving up (buy too late).
Last week, both China and US markets have been correcting quite a lot in just few days. Many are worrying whether the stock market will be heading down.
However, if you look at the general chart, it is still trending upwards. Do the people over react by selling the stocks? I guess the answer is quite obvious.
The difference between speculation and investing is the amount of risk involved. In investing, people are lower risk as when they buy, the price is undervalued. In speculation, people tend to seek for abnormal gain by betting. There are still chances speculation can make money – they are when the risks are being controlled properly. Traders make money based on speculation using technical chart even they do not evaluate the valuation of the investment when they enter a trade. However, they are controlling the risk by analyzing how likely the price will continue to go up using chart and they place a stop loss and take profit order before they enter in a trade. The stop loss and take profit are controlling their risk.
If they always make 2 times compared to the risk they are taking, they can make money in a long run. Let’s run this mathematic question:
If the probability of winning is 50% and the probability of losing is 50%.
A trader has placed 100 trades.
When he wins, the gain is RM 100, when he loses, the loss is RM 50.
Total gain (+) or loss (-) for the 100 trades will be:-
( 50% x RM 100 x 100 trades)[gain] – (50% x RM 50 x 100 trades)[loss]
= RM 5,000 – RM 2,500
= RM 2,500
See? Both speculation and investment can make money. The key is the time for analysis and the risk control method.
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