Stock speculation became common because profitable stock investing is not so simple. Profitable stock investing requires skill for implementing it successfully. But stock speculation is comparatively an easier skill to learn. In fact, speculation comes naturally to human beings. See how much people like a gamble for fun. Rolling the roulette and leaving the rest on luck is so easy. It is far easier to adopt an easier skill. A difficult skill takes time to master. Stock investing is no easy game that one can always win with luck. It requires a serious understanding of business fundamentals and the application of investment logic.
Suggested Reading: Stock Investing Strategies.
#1. Why can’t we buy stocks as it is?
What’s the point in doing so much study when we have no control on the underlying business?
Its true that stock-holding does not give control on the business.
But actually this is not the point…
We are better off without business control.
Stock investors does not want to get into the hassle of controlling a firm.
But this does not mean that we start investing blindly.
In short-term stock price can be very volatile.
The speed in which market price of stocks moves up-and-down creates a sense of panic among uninformed investors.
Informed investors, who are aware of their stocks business fundamentals keeps their calm.
They do not worry about short-term volatility.
They only focus on long term growth trajectory.
Price of company which has strong business fundamentals (like blue chip stocks), will always grow.
No matter how volatile is its price in short term, in long term, price appreciation is certain.
#2. Indirect cause of speculation in stocks
Not all stock-price volatility is due to speculation.
Price volatility of stocks may also be caused by other reasons.
Other reasons for stocks volatility can be lump-sum buying and selling of stocks by mutual funds, financial institutions, large investors etc.
Any buy/sell decision of such investors is followed blindly by public.
The herd mentality of public inflicts further price volatility.
When common men me gets a news that big investor like Warren Buffett has bought / sold some stocks, they also join the party.
Such action of small investors is an example of speculation.
This type of speculation is triggered by a strong investment logic.
But it ultimately becomes speculative when public starts to copy the actions blindly.
#3. Stock speculation became common because it is easy to follow
Qualified investors spend considerable time reading companies financial statements.
It is both time consuming and not-easy to follow.
But stock speculation is easy.
It asks people to look JUST at stock price trends, FULL STOP.
Speculators care least about if they are buying/selling share of MICROSOFT or Mr.Unknown company.
For them, price movements and trends tells the whole story.
This makes speculation easy to follow.
Apart from this, if one is also lucky, stock speculation makes quick-easy-money.
Stock speculation became common because majority investors has less patience to learn fundamental investing.
The temptation to gamble for quick profits is far stronger than desire to learn fundamental investing.
‘Buy low and sell high‘ concept is far easier to follow than learning to read balance sheets.
Majority are engaged in short-selling.
The do this to make quick money.
But this is also true that 90% of speculators loose money in this process.
The balance 10% speculators who are making profits are ONLY LUCKY.
But soon they too will run out of luck.
#3.1 Trained stock traders are not always gambling…
Stock traders are the ones who fancy speculation more than anyone else.
But they are not really gambling with stocks.
Instead they take calculated risks. They have so much information available at a time about a stocks that they can afford to gamble.
When such people are speculating they are actually not relying only on chance.
They have some extra-information that other don’t have.
With this extra information in hand, they also practice their trade little differently…
Speculators often invest in stocks which are very volatile.
This allows them to avoid high holding periods.
Means, as high-and-low cycles are happening more often, profit making cycles are also repeating faster.
Trick is to tap an interesting stock at a time when momentum is upward.
Speculators also trade in large volumes.
For them even small profits/share amounts to huge gross profits.
#4. Value Investors need speculators…
Yes it is true.
Stock speculation is very advantageous for value investors.
Speculators often practice day-trading.
The amount of money that flows-in the market because of day-trading is fantastic.
This maintains sufficient liquidity in the market.
As day traders are also short selling, it allows to keep a check on bullish price movements.
Unknowingly but most of the time, stock speculators does prevent bubble formations in the market.
Maybe this is one of the reasons why stock speculation was allowed to become common practice.
When investors invest in stocks their objective is either capital appreciation or dividend income.
In order to achieve these to objective they focus their attention on fundamentals of stocks.
When value investors identifies a fundamentally strong stock, they add it to their watch list.
They do not go and buy it straight away.
Value investors wait for the right buy-moment.
This right moment comes what speculators go berserk.
Due to some negative sentiments, speculators start selling even fundamentally super-strong stocks.
[Remember, for speculators MICROSOFT and MR.UNKNOWN is not different]
This actually provides great buying opportunity for value investors like Warren Buffett.
In such moment, even best of stocks are available at price below its intrinsic value.
#4.1 Speculation triggered by inside trading
Speculation triggered by inside trading also exists in the share market.
Inside trading is inflicted by ‘inside information’ of the company.
What is inside information?
Inside information is that information about company which has potential effect on its future earnings which outsiders are not aware of.
This information can be both positive and negative.
Positive inside information will lead to earnings growth.
Negative inside information will lead to earnings fall.
One common example of such inside information is shares buy-back.
If company board of directors decides to buy-back its shares, it means EPS of the share will rise.
Any insider who has access to this information and buys the companies shares in this period is called inside trading.
Insider has access to this kind of information earlier than others.
If they initiate the buying and selling of their stocks it encourages speculation.
When outsider notices this behavior of an insider, they also start blindly duplicating the same action.
Inside information’s like:
- Expansion plans,
- Modernization projects,
- Merger with other companies,
- Launch of a new product,
- Split of consortium,
- Shares buy back,
- Increasing share outstanding in market etc..
All these and many more factors can lead to this type of speculation.
Such big decisions in companies are taken by the board of directors of the company.
Such people know these information much ahead before the market and other investors.
So, actions of insiders (specially of top managers) are very closely watched by the market.
When these top managers buy/sell their stock-holding of company in bulk, it inflicts speculation in its stock.
As soon as the news become public, institutions and common men also starts buying/selling these share.
This dramatically influences the market price of shares.
#5. Speculation triggered by financial institutions
Speculation is also inflicted by financial institutions.
In India, normally 30% of a company’s shares are held by financial institutions.
Approximately, another 30 percent is held by promoters or company themselves.
It means, the numbers of shares available for trading (for public) in the market is ~40%.
In a situation where everyone wants to have their share of pie of stock market success, this small fraction of available share is not sufficient.
In this situation every move by financial institutions has big speculative effect on the share price.
Holding of financial Institutions are very big.
When they decide to buy or sell a share, it creates a big demand/supply imbalance.
When common public is not buying shares, but financial institutions are buying shares, in this situation shares become scarce.
Financial institutions are buying majority shares. In case market price shoots-up.
This is a point where common public starts buying and price starts to shoot-up like mad.
When common public is not selling shares, but financial institutions are selling shares, in this situation shares become excess.
Financial institutions are selling majority shares. In case market price falls.
This is a point where common public starts selling in panic and price starts to bottom.
#6. Speculation due to impatience of people
Stock speculation became common because majority do not have patience.
People cannot wait and hold stocks till dividend starts to drip-in.
Leave aside dividend, people do not wait even to allow capital appreciation to take place.
For such people buying today at X price and selling tomorrow at X+1 is more interesting and easy.
Such people do not have aptitude for stock investing.
They must develop patience to hold stocks for longer time.
What people with aptitude for stock market do?
These people are called investors.
They first learn to read companies financial statements.
Then they try to estimate intrinsic value of a stock.
When they know the true value, then they take calculative risk based on safe assumption.
Even fundamental investing is risky (as it is based on assumptions) but speculation is based on only ‘hope’, which is not at all scientific.