What Is Speculative Trading

What Is Speculative Trading

In the vast ocean of the stock market, we can only participate in two ways. We can invest in stock or carry out speculative trading. Unlike traditional investing, which promotes long-term investment and growth, in speculative trading, buying and selling is a short-term game wherein investors earn through price fluctuation. 

Speculative trading is commonly believed to be rewarding and risky, but it's not true. Speculative trading is wholly based on mere speculation, which can either help us gain some profit or make us lose some money.

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Overview Speculative Trading

Speculative trading is famous and accounts for daily trading in India. At the core, speculative trading is a strategy based on market fluctuations. It helps in seizing short-term opportunities in the trading market. It is a high-stakes venture that can offer the traders opportunities and challenges.

As we embark on the exploration, we will learn about the tiny details and intricacies of speculative trading and shed light on its mechanism, its different types, characteristics, and the dynamic interplay between risk and reward that captivates traders.

The Working Mechanism of Speculative Trading

It's essential to understand the working mechanism of speculative trading across different asset classes like- equities, bond markets, and forex markets. This will provide you with valuable insights into the dynamics of speculative trading.

Speculation and Equities 

Equities (stocks or shares) represent the ownership of a company. Speculative traders analyse market trends and company fundamentals to forecast price movements. In this scenario, traders apply strategies like day trading and swing trading to identify the entry and exit points.

Speculation and the Bond Market 

A bond is a debt safety in which borrowers issue bonds that allow them to raise money from investors inclined to lend them money for some time. In the Bond market, speculators focus on the interest rate and credit ratings. They monitor the economic indicators that can influence bond prices. Through continuous engagement with interest rates, speculators bet on changes in the interest rates and their impact on bond prices.

Speculation and Forex Market 

The foreign exchange market involves the exchange of currencies. Speculative trading in the forex market is based on economic indicators or geopolitical events and the strength of the currencies. Any decision by the central bank can cause a rapid fluctuation in the price movements of the forex market.

Example of Speculative Trading 

Let’s assume the stock IRFC is currently at INR 75, and you are speculating that it will reach 150 in 2 months. In such a situation, you utilise the future contract of IRFC to initiate speculative trading. You purchase the future contracts of IRFC at 100 with an expiry of 2 months from the day of the transaction. After one month, the share price is 120, so you decide to gain some profit without waiting for the expiration date and sell off the shares.

Types of Speculative Trading 

There are numerous ways to facilitate speculative trade, which can be classified into the following types-

• Arbitrage: When you take advantage of the price movement in two or more markets and level the security pricing in those two markets. This type of trading requires specialised speculative skills and deep knowledge.
• Rigging: This process involves artificially forcing up the market price of the shares. When the bulls of the market manipulate the prices of the shares, it is called rigging.
• Options: These are considered highly risky. In options, they give the traders the right to buy and sell shares whose value is pre-determined, known as the strike price.
• Cornering: When an individual or a particular group controls the supply of a specific share, it is known as cornering. The goal of cornering is to monopolise and manipulate the supply and demand of securities. The speculators enter the market, buy the available securities, and wait till the actual delivery of these securities. Once they have enough shares, they will make such securities go out of the market.
• Blank transfer: The transferee’s name is not mentioned in this case. It is a way of transferring securities unlimited times using this procedure.
• Wash Sales: When artificially inflate the demand for a particular security, it is called wash sales. In this, securities are first sold and then repurchased at a higher price, leading to price inflation.

Investing VS Speculation 

The foremost distinction between investing and speculation is the extent of risk a trader is ready to take. While investing, a trader is typically taking low-level risks, but in speculation, the risk level is relatively higher to gain better profits.

To gain profits, investors sell their stocks and mutual funds. Speculative traders are open to putting their money in securities with a higher risk of failure.

Benefits Of Speculative Trading

Speculative trading is risky but also offers potential benefits to the traders. Here are some of the potential benefits of speculative trading-

1. Profit potential: Through speculative trading, traders can earn significant profits; as traders aim to capitalise on short-term price movements, they sometimes make more profits.
2. Quick Returns: Since speculative trading is based on short-term monetisation, the returns are immediate.
3. Diversification: Speculative trading can be done across various asset classes like- the forex market, bond market, and equities. Through this diversification, their risk is diversified, and risk is not burdened on one specific asset.
4. Ensures liquidity: Some traders focus on liquid markets where buying and selling can be executed quickly. This helps traders to enter and exit the market efficiently.

Risks of Speculative Trading 

1. Market volatility: Since the traders are entirely dependent on the market and based on speculations, they make a trade move, which can always go wrong. Since the market is dynamic and volatile, things can go south, and you can face losses.
2. Misinterpretation of Data: Traders can face loss due to lack of information and incorrect information analysis.
3. Market timing: Speculators must know the correct entry and exit time. Failing to do so can result in missed opportunities.
4. Legal Risks: There are continuous changes by the regulatory board; if you miss the unexpected legal developments that can impact the speculative trading strategy, traders can face legal risks and losses.

Conclusion

Speculative traders need to be aware of market changes, conduct thorough research, and require a high level of planning. Traders need to know the entry and exit time of the market to gain some profits. 

Speculative trading comes with its challenges. In some cases, speculative traders face losses due to sudden market changes and wrong data analysis.

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