Difference between Trading, Investing and Speculating
Trading, Investing and Speculating are as similar as engine, clutch and gear of a car. Simply put, all three are great for your car, extremely important to run it but none can be substituted by the other. They are very much different and here’s how:
Trading works on “Buy and Sell” approach. It is a short term activity in comparison to investing. It works on the principle of buying something at a low price and selling it for a gain. The main factor which differentiates trading from investing is the duration for which the stock is held. If you miss the right time, then it might lead to a loss. In trading, you have to look for the current performance of the company to hit the higher price and book profits in short term. But it mainly concentrates on a few stocks and its prices instead of diversifying and hence could be deceiving. Sometimes the holding period of stock is as short as a few hours. This kind of trading is known as Intra-day trading.
These short term fluctuations are caused by the variations in demand and supply of an asset. Traders mainly rely on technical analysis, which attempts to predict short-term price fluctuations using graphs, charts, and oscillators.
Investing is the purchase of an asset with the hope of getting returns. Investing works on “Buy and Hold” strategy. It is a long term investment which results in large profits. It is a proactive use of cash to generate wealth. The decision making while investing largely depends upon the fundamental factors such as the performance of the company, quality of management etc. It has moderate risk attached with it. Investment mostly lasts for long term. The main profit lies in the value of the assets. It has a stable kind of income which is less volatile. An investment is generally made by analyzing the primary trend.
Short term fluctuations remain insignificant in investing since it works on long term trends. In investing,dividends are paid more importance, thereby only quality stocks are held for years. Investors invest in value rather than trends and get paid off well via compounded interests in a longer term. Investment requires analytic approach towards the company’s past history, business model, performance, future prospects etc. without wasting efforts in analyzing short term goals.
Speculating is about short term profits gained in smaller trends. Decision making in speculating is based on tips, rumors, news, small trend analysis, and gut instincts. The risk involved in speculating is higher than that of investment. It is dependent up on the market psychology and its factors. It is quite volatile as it depends on secondary trends, which might lead to loss at times. The intent of profit in speculating is the higher price of a stock. Speculators focus on the potential of earning money on sudden price movements instead of looking for ownership of the company by holding the shares. They carefully analyze patterns, study past history of the stock prices to locate a trend and gain through it. Speculators are quite influenced by the short term price swings.
Trading, investing and speculating are three different activities of the stock market. The risk factors, methodologies, profit margins, the fundamental strategy behind them remains different. While one might be suitable for a person and help him gain profits other might not suit him and cause loss. Therefore, the above differentiation could be helpful in determining which mode of earning through the stock suits best for you and yields you better returns as per the convenience.
ABCD of Stock Market
Ramesh: Hi Suresh! I’ve heard you bought a new house and you are soon going to buy a car.Congratulations! Did you win a lottery? Or is itan ancestral fortune?
Suresh: Yes you’ve heard it right. I bought a new house, but I haven’t got any lottery, neither an ancestral fortune nor a new high paying job. But yes, I have got good returns out of my simple investments in the stock market.
Ramesh: Oh! I have never thought that stock market could yield such good returns. It always seems like a tedious process. Also, I have heard it is a very risky investment and people often end up losing money. May be it is not my cup of tea.
Suresh: I feel you have got the information about the stock market from very wrong sources. It is a risky investment I agree, but the risk could be minimized by proper analysis and people like me have really earned well out of it. Moreover, it is not at all difficult, there are just a few basic tips; once you understand them and start reading the latest updates you could soon be a pro.
Ramesh: Really! I’ve just been thinking about it in a wrong way since long. Will you help me in understanding these basics of the stock market? I would also like to invest in it.
Suresh: Yes sure! To start with, the stock market is a market place with buyers and sellers present in the form of a loose network of economic transactions, to deal in stocks (shares). These stocks represent the ownership claims on businesses. People often buy and sell them to generate earnings.
Ramesh: But how does buying or selling stocks generate earnings?
Suresh: The price of these stocks vary from time to time depending on the value of the company. This value depends on various economic factors. There are three methods in which one can generate earnings based on the convenience and risk capacity. The first method is by investing, in which we buy stocks of promising companies and keep them for long term and sell them years later after the value of stocks largely increases. The second method is by speculating- where we invest in the smaller price fluctuation of stocks and earn between the margins. Speculating is a short term process and is riskier. The third method is by trading, which is a very short term process. It yields lesser returns and has to be performed multiple times. It can last as short as a few hours. The risk quotient remains higher in trading.
Ramesh: Can you please elaborate on the pros and cons of the three methods?
Suresh: Yes, definitely. If you plan to invest then you have to analyse the company. Go by the fundamentals i.e. the performance of the stock. If you are more interested in quick but high margins, you can speculate by understanding the trend of a stock and sell it as soon as you see a close high. At the initial stages, speculating could be riskier. If you are interested in very quick small margins, you can trade by working on the immediate rise and fall of prices, which is solely based on tips, analysis and instincts. Even the risk quotient for trading is high and you have to involve into many trades so as to generate a decent earning.
Ramesh: I have got the idea of the three modes to earn from stocks. But I still did not understand how to know the direction of the market. Could you please explain?
Suresh: Knowing the direction is based on the analysis which could be done using graphs in different time frames as per the requirement. Locate all the lows of a stock and see if the slope goes upwards. An upward slope indicates uptrend and a downward slope depicts downtrend. Similarly, if you see the slope going in a reverse direction it shows a trend reversal in the market.
Ramesh: Thank you! The information you have given has created a better understanding of the stock market in me. I would definitely do my homework and invest in stocks too.
Suresh: I am glad I could help. Happy Investing!
Investing in an upcoming IPO? Consider these factors before investing
Usually, when a company comes out with an initial public offering (IPO), there is a lot of noise around it. Nobody wants to miss an opportunity of investing in an IPO. However, not all IPOs provide desired returns. Some IPOs fail miserably and people face losses.
Here are some factors one should consider before investing in an IPO.
Check company background
Before investing in an IPO, always read as much as possible about the business of the company and its operations. Evaluate how the company has performed financially over the past few years. It is very important for a company to be financially sound.
Future prospects of the company
Understand why the company is coming out with an IPO. Talk to the management and understand the future plans of the company. Evaluate how the money collected from the public will be utilised in future - whether the company will use it for expansion, to pay off loans or for anything else.
Look at the Valuation
Valuation is one of the most important factors that one should consider while investing in an IPO. The best way to evaluate the valuation of any company is to compare its price with that of its peers in the listed space. If the business of the company is new, and it has no peers in the listed space, you can simply judge its valuation by using the price to earnings ratio and return on equity. The price to earnings ratio is calculated by dividing the share price of the current stock by the earnings per share.
Stay cautious of over-subscription
The number of shares that a company offers during an IPO are limited. Moreover, the allocation of shares to each category of investors, including the retail investors is pre-decided. A lot of times, the number of applications made is higher than the number of shares which are on offer. So, the allotment is done proportionately and there are chances that you may get fewer shares than you applied for.
Always read the prospectus
The fine print contains all the details related to the company - business of the company, summary of the financial statements, capital structure, objects of the issue, management views etc. The prospectus gives an overall information about the IPO and hence it is easy to decide if the company is worth investing or not.
Simplifying the IPO Process for Listing Your Company on Stock Exchanges
It is a matter of great pride for any company to go public. However, there is a certain process which a company needs to follow in order to come out with an Initial Public Offering (IPO). This process involves six steps post which a company can list itself on the exchanges.
Appointing an Investment Bank
All banks, public or private have an investment division which takes care of the IPO process. All one needs to do is to fix up a meeting with any of the banks and pay the required fees. Thereafter, it is the job of the bank to make your company public.
Registration Forms to SEBI
Securities Exchange Board of India (SEBI) is an autonomous body which regulates the entire finance and investment markets in India. SEBI’s sole purpose is to provide transparency and protect the investor. Every IPO has to mandatorily register with SEBI and once it gets the approval, the IPO is ready to get listed on the exchanges.
Red Herring Prospectus
The Red Herring Prospectus is a document which contains all the information about the IPO - the size of the IPO, financial statements, company history and the future plan of the company.
Advertising includes everything from putting up hoardings to giving interviews to news channels and magazines. Basically, the more your company is talked about and known, the more demand it will attract from the investors, which in turn will help in a better listing price on the exchanges. In the past, companies like Just Dial, Twitter & Facebook have used heavy advertising as a means to promote and attract investors.
Price Band Set by Investment Bank
The investment bank goes through all the financial statements of the company and sets a price band for prospective investors to bid within the price band. However, retail investors are not the only players who participate in the bidding process. Mutual funds, institutional investors, hedge funds and insurance companies also participate in the bidding process. The process of bidding between price bands is called price discovery. The price is set on the basis of demand and supply. One important thing to note here is that, when you are bidding for the shares, you cannot bid for one share. If one lot consists of 10 shares, you have to buy the entire lot of 10 shares.
Book Bidding Process
Once the bidding is done, the banks identify if the issue is over-subscribed or under-subscribed. If the issue is over-subscribed, the banks release the shares at the highest band and the share is listed.
If you wish to know when the right time to buy a stock is, you can get to know by calculating the price-to-earnings ratio (P/E ratio). This ratio is calculated by dividing the share price of the current stock by the earnings per share.
Trading in Equity? Read this checklist before progressing into the equity market!
Trading in equity market can be compared to marriage to a large extent. One needs to have commitment and long-term approach for both. However, here is a checklist one must follow before investing in the equity market.
When an investor starts investing in the equity market, he must invest with a long-term view in mind. Investing for a longer period of time can multiply your investments while giving you superior returns. Equity markets can be quite volatile in the short-term as it tends to react to every announcement made in the country. A long-term approach provides stability to your portfolio.
Avoid Relying on Tips
A lot of people think that they are experts in the equity markets after investing and making profit a couple of times. They go ahead on giving advice to their fellow mates regarding which stock to buy and which to sell. When you are new to trading, a lot of people will give you stock tips. Refrain from acting on such tips as you can end up making losses. It is always better to consult your financial advisor or a person who has expertise and knowledge about the equity market.
Do not depend on the News Flow
One must avoid investing based on any news which is out in the market. Stock markets take some time to adjust to any news. So, making hasty decisions and investing quickly based on the news flow can prove to be a bad idea.
Avoid Timing the Market
Equity market is something once cannot control. Even a person who has been investing in the equity market for a decade or two cannot time the market. If you try timing the market, it is very likely that you will take a lot of wrong decisions and end up ruining your portfolio.
Do not Speculate
One must avoid speculating an event before it occurs. Speculative investing is when an individual assumes a certain event, its impact on the stock and invests accordingly. If an individual speculates that the stock will go up after a particular event, and the event does not occur, or the stock does not react as predicted, one can bear a huge loss.
IPO Investment - How can an individual invest in an IPO?
Initial Public Offering (IPO) happens when a company decides to go public and list itself on the stock exchanges. Buying shares of a company is very easy when you buy it from the secondary market i.e. when the company is already listed on the exchanges. However, when a company comes out with a fresh issue, an individual needs to buy shares directly from the companies.
The Buying Process involved in an IPO (Initial Public Offering)
Stay aware and updated
Usually, when any company comes out with an IPO, it advertises heavily in the media. This is because the company wants to gain maximum publicity in order to ensure that the issue is a success. It is through this advertisement that one gets to know about the upcoming IPOs. It is very important that before applying for any IPO investment, an individual goes through the company’s financial statements, its track record and management’s future plans.
Get an Application Form
An individual needs to fill up the application form which is easily available with the brokers or any agent who sells mutual funds. The forms come free of cost. Fill up the form as per the directions mentioned in the form. Also, attach a cheque for the amount of shares you wish to buy. There is a minimum number of shares one needs to buy for specific issues, which is specified in the application form. Submit the form within the mentioned time frame.
An individual can also apply for an IPO online through ASBA (Applications Supported by Blocked Amount). This is a process developed by SEBI while applying for an IPO. Through ASBA, the IPO applicants’s money doesn’t get debited until shares are allotted to them. An individual can login to his netbanking account and apply for IPOs directly.
While there are a lot of companies which come out with their IPO, it is not necessary that every company’s IPO perform well. There are some investors who have faced huge losses by investing in wrong IPOs. An individual should be very sure about the company and should have faith in the company’s management and its growth prospects before IPO investment.