Everything You Need to Know About Speculative Trading
It takes years of practice to understand the complex systems and processes involved in financial markets. There are different financial markets and, in all markets, traders strive hard to make profits. Every trader has a different motivation and a different strategy to gain success. One of the most common traders found in these financial markets is a speculative trader.
In this article, we will talk about speculative trading, how it is different from investing, and the advantages and disadvantages associated with it.
As the name suggests, this trading is specifically based on speculation. In this, traders buy an asset or any other financial instrument based on the market price movement. Here, investors make decisions based on the technical analysis of the price action of the market rather than the fundamental analysis of that security or asset.
Some people believe that speculative trading is risky while others think it to be highly profitable. However, both are not true always. As trading is based on speculation, you do not move in a single direction. If you expect a price to increase, you can buy. On the other hand, you can decide to sell when the price is expected to decrease. In investing, you mainly look for purchasing securities or contracts to increase in value.
Speculation And The Forex Market
In speculative trading, when a trader purchases a foreign currency, it is termed as currency speculation. Here, an investor purchases a currency to sell it when the currency price appreciates. Forex market is the largest financial market in the world with transactions worth $6.6 trillion per day. This market runs for 24 hours a day and an investor can buy and sell in seconds with high-speed electronic trading platforms.
Speculators actively trade in the foreign currency exchange market due to several reasons. Firstly, this market has frequent fluctuations in the currency exchange rates on both intraday and long-term basis. Further, this market also provides wide opportunities as there are various currency pairs available for trading. Also, as there is a high amount of leverage in forex, traders can generate substantial profits with a small amount of trading capital.
Transactions in forex mainly refer to the buying and selling of currency pairs like EUR/USD through options or simple exchange. Asset managers and hedge funds mainly dominate the forex market. Because of this reason, forex speculation is sometimes confused with hedging practices which means buying and selling a currency against market movements.
Risks Involved In Speculation
The risks involved in speculative trading involve an uncertain percentage of positive gains or negative loss on a particular investment. However, you must understand that risks in the speculation is conscious or you can say it is a known risk. For example, a natural disaster happening is not a speculative risk but a fall in the value of an asset is a speculative risk.
The purpose of financial trading is to earn rewards and even speculative risks can be dangerous in that sense. Thus, to be a good trader, you must learn to manage your risks properly to maximise your profits.
How To Speculate In Trading
Speculation in trading can be done based on fundamental analysis or technical analysis. Every trading includes a technical analysis of its market based on different charts. This helps you determine the direction of the price. To speculate, you need to learn some of these technical indicators.
Remember, speculative trading is short-term trading. Thus, there is no need to analyse several years of financial data. This will not help you. You need to speculate on prices going up/down over a short period and then trade on it.
Types Of Speculators
A speculative trader aims to make money through the change in financial instrument prices. There are speculators based on their trading style, directional view, and the type of trades they do.
Based on trading style
Day speculator: These speculators do not have any specific qualifications. They are termed so because they trade often. Like other day traders, they also hold a position for a day and close when the trading session is over.
Swing speculator: As opposed to the day speculator, a swing speculator holds the position for several weeks hoping that he or she will capitalise on the gains during that time. For this, the trader will determine where the asset price will move and accordingly take a position.
Based on the directional view
- Bullish speculator: A bullish speculator will buy securities with the hope of selling them at higher prices in the future. The bullish speculator always expects the price to rise.
- Bearish speculator: This speculator expects the price to fall in the future. He will sell securities to repurchase them at a lower price in the future.
Based on the type of trade:
Speculators can make different types of trades and these can be:
- Future contracts: In this, buyers and seller sell their assets at a fixed price at a pre-set point in the future. The buyers buy their assets once the contract expires.
- Put and call options: In Put option, a contract owner has the right to sell their securities at an agreed price at a specific period. On the other hand, in the call option, a trader can buy the asset before the contract expiry date at a previously agreed price.
- Short selling: In this, the trader speculates that the price of an asset will decrease in the future, and then take a position and short sells.
Tips To Speculate Like A Successful Trader
Don’t let risk affect your behaviour: The perception of losing creates a psychological barrier in trading. Sometimes a trader wins 2/3rd of their positions but still face losses because they do not use stops. You can manage your emotions by either putting a trailing stop or manually moving a stop when the price is moving in your favour. With this, the fear of loss will not stop you from trading.
Bring a positive mindset to the charts: Forex speculation involves inevitable losses. However, one way to keep yourself positive is to look at your losses as the cost of doing business.
Keep a balance between fear and greed: Both fear and greed can alter your decisions, cloud your judgement, and can lead to wrong decisions. It is human nature to be greedy when in a losing position and to be fearful of a winning position. However, you must reverse this thinking. Try to be a little greedy when you are winning. On losing, be a little fearful and use a break-even stop to reduce your risk.
Difference between investing and speculation
The major difference between investing and speculation is the amount of risk a trader can take. An investor generally takes a low to medium risk to earn a satisfactory return on their capital. On the other hand, speculators trade at a higher level of risk hoping to get higher returns from their bets. This speculation can go either way.
Investors generally buy and sell stock CFDs, stocks and ETFs, mutual funds, and other financial assets to gain profit. While speculators put their money in different instruments with a high probability of failure. This also includes CFD and options.
Investors make their trades based on analysis and research. They evaluate different patterns trends and assets by using technical analysis and fundamental tools. With fundamental analysis, they can identify the factors that affect securities value. Statistical trends in technical analysis help an investor to find opportunities in the market.
Advantages Of Speculative Trading
✅ Boosts the economy
Speculators are ready to take more risks than the average investor. They readily invest in companies that are unproven or whose stock is available at low prices. With this, they provide capital to young companies to expand and grow. They also help companies that are going through tough financial times. In this way, speculators support and drive the overall economy forward.
✅ Liquidate the market
Speculators trade actively in the market and this adds liquidity to the market. Without speculators, the market will be illiquid having large spreads between ask and bid prices. This can make it difficult for investors to buy and sell assets and instruments at a fair market price. The liquidity in the market facilitates easy and smooth exchange between sellers and buyers at all times.
✅ Promote profitable trades
With speculative trading, you can earn profits through price movements in either direction. If you are holding a long-term investment, you can hedge your risks with it. Let us understand this with an example. Suppose you own stocks of a company that you know will outperform in the next 10 years. However, you know that current market sentiments may lead to the fall of that stock in the short term. So, instead of selling the shares, you can take a short position through a CFD contract to gain profits through short-term price movement without disturbing your portfolio.
Disadvantages Of Speculative Trading
Sometimes, due to speculation, the price of an asset moves too high or too low in value that does not reflect its true value. In other words, speculations can lead to price fluctuations that can lead to long-term impact and the stability of a company or the whole economy.
For example - people believe that high oil prices in the 21st century i.e., up to $100 a barrel is mainly due to speculations rather than the actual supply and demand conditions in the market.
❌Creates economic bubble
A disadvantage that is associated with the unreasonable prices in speculation is the formation of an economic bubble. An economic bubble is formed when the price of a commodity or any financial instrument rises due to the high demand created by speculators. This drives more speculators to move towards that commodity causing prices to rise further.
This cycle repeats itself multiple times inviting more and more buyers and driving prices higher and higher until the bubble bursts.
You may recall the economic bubble of the 2008 global financial crisis in real estate. Initially, the price of real estate kept on rising owing to the high demand by the speculators. Finally, after saturation, the price began to fall to a more realistic fair market price. As a result, many investors were left with properties that had values much less than what they paid.
Speculative trading is a primary force in the world of financial markets. As long as people will trade in assets and financial instruments with profit potential, there will be speculators in the market to make money. You just need to be careful and get yourself armed with all the tools and information related to speculative trading to enhance your chances of making a profit.
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