"The stock market is nothing but speculation", often hisses my friend, who is a leftist intellectual. And after he reads this he will be transformed into an angry and irritated leftist intellectual who will have to be placated over some liquid refreshments but that's OK because this whole routine is something we've been doing for many years now. However, that doesn't quite change the fact he firmly believes in this speculation business. That the stock market is nothing but speculation is an article of faith in some circles. The strange thing is that this belief extends to circles far wider than my friend's. Large swathes of the media, political and official circles believe this. Even though the so-called 'investing community' doesn't seem aware of this, this view permeates much of the general attitude in our country about stock investing. The curious thing is that few people are at all clear about the definition of 'speculation'. What exactly is this 'speculation' that stock investors are accused of and how is it different from non-speculation?
The dictionary lists the following words among the synonyms of speculation: conjecture, rumour, gossip, assumption, guesswork, hearsay and supposition. It's clear that the word has a bad reputation, but that doesn't help us figure out what is speculation and what is investment. One definition that's surprisingly common is that speculation is 'engagement in business transactions involving considerable risk but offering the chance of large gains, esp. trading in commodities, stocks, etc., in the hope of profit from changes in the market price.' Unfortunately, this is a somewhat circular idea that isn't of much use unless one can define what is 'considerable risk'. In any case, at the end of the day, all investment hopes to 'profit from changes in market price' so that's not much of a distinguishing factor. In my view, the difference between an investment and speculation boils down to not what an investor does but to what he wants and what his level of knowledge is. Think about it. Someone tells you that X stock is going to go up and you go ahead and buy it without any further thought. By comparison, someone else could know everything about X, it's prospects, the industry, it's peers and come to the conclusion that it's a good buy. Clearly, the very same action, depending on how much an investor knows, could be intensely speculative or could be a carefully considered investment.
Speculation really is a state of mind, but unfortunately it's one which generally has poor self-awareness. Are you, in this sense, a speculator? Here are a few checkpoints. The more of these you answer yes to, the closer you are to being a speculator.
- You never try to balance risk between different investments.
- You buy stocks of companies without a clear idea of how their businesses work.
- You choose which new issues to invest in based on the ads of those new issues.
- You buy stocks because they've gone up.
- You sell stocks because they've gone down.
- You think a stock with a lower price is cheaper than one with a higher price.
- You think the previous checkpoint is a mistake.
- You answered yes to most of these checkpoints and yet you are sure you are an investor and not a speculator.