Speculative trading is a form of trading that looks to profit from market price movements - whether the market goes up or down. It stands in contrast to traditional investing, which looks deeply at the fundamental values of an investment.
What is Speculative Trading?
Contrary to popular belief, speculative trading is not necessarily super high risk and high return in nature. Nor does it always refer to trades that have the potential for significant gain.
Instead, speculative trading revolves primarily around, you got it - speculation. So the art of speculation is not fixed in a single direction (eg. versus investing which primarily looks for the investment to increase in value). This means that speculation can allow us to buy an asset (if we expect its price to increase) or sell an asset (if we expect its price to decrease).
In terms of the risk involved in speculative trading - it can be as well managed as any traditional investment out there. There is your bias (up/down direction) followed by the levels which you would close out a profit (or a loss). So in many senses, it is not that different compared to traditional investing and in fact, the ability to play both directions (up/down) gives you a slight edge over investors who only look for investments that will rise.
We can see examples of speculative trades in black swan events. So what exactly are black swan events? They are events that are extremely rare and difficult to predict with a huge economic impact that follows after. An example of such an event would be the 2008 Financial Crisis.
The 2008 global financial crisis
So what happened in 2008? The global financial crisis was caused by the housing market bubble that began to form in 2007. Lower interest rates reduce the cost of borrowing for businesses and consumers. The result was an increase in home prices as homeowners took advantage of the low interest rates to take out loans they could not afford. These loans were then repackaged and sold as low-risk financial instruments, developing a secondary market for these subprime loans.
Eventually, interest rates rose and home ownership reached a saturation point. Home prices tumbled, triggering defaults and sending out huge ripples that collapsed the global economy in 2008.
So how is this related to speculative trading? While most investors were optimistic about the economy, Michael Burry, a hedge fund manager was one of the first investors to speculate and profit from this subprime mortgage crisis, as he recognised and predicted the collapse of the housing market bubble. He shorted the market by persuading investment banks to sell him credit default swaps (which will compensate him in an event of a default) against subprime deals he saw as vulnerable. As a result of this speculation, he earned a personal profit of $100 million.
How do you speculate?
There are many different ways to speculate in trading. They can be due to fundamental reasons such as our example above on the subprime crisis. More often than not, though, it is due to technical reasons (using technical analysis).
In the world of trading, there is a tremendously popular technique called “technical analysis” which uses analysis on the charts (primarily) to determine the direction of where the market is heading. Little to no analysis is done on the fundamentals of a company before taking such trades off technical analysis. What types of technical analysis are there to help forecast such prices? You can take a look at one of our beginner guide here.
Speculative trading also tends to be more short-term in nature - hence the reason why staring and analyzing years worth of financial data of an asset is not going to be very useful for it. Traders tend to have a short term bias - believing that the market is either going to head up/down over a short period of time and then take a trade on it.
What are the risks of speculation?
It is also important to understand the risks involved in speculation. Speculative risk is a category of risk that, when undertaken, results in an uncertain degree of positive gain or negative loss of capital value on a particular investment. All speculative risks are made as conscious choices and are not just a result of uncontrollable circumstances. What this means is the risk that an investor takes on when taking speculative risk is a known risk as opposed to an unknown risk.
An example of this would be the risk of a natural disaster happening, this would not be speculative risk necessarily if it occurs as the investor would not have consciously considered the probability of a natural disaster occurring when making the speculative investment or trade.
On the other hand, if the asset value drops by 0.5% when an investor makes a trade that they expected the value to increase on, this is considered a speculative risk as the trader knew that there is consciously aware that the market for the asset will fluctuate, and thus he can never accurately predict the asset value with extreme precision. In short, a known risk is a speculative risk but unknown risks are not speculative risks.
When it comes to trading, risk shouldn’t always be looked upon too favourably. The purpose of trading is to maximize rewards, not to take dangerous risks. Therefore, by those standards, even speculative risk is dangerous when it comes to trading.
The trader should be looking to maximize their returns while minimizing all their risk categories, including speculative risk. As it takes a risk to make rewards in the world of financial trading it should be the goal of any good trader to manage their risk profile to make rewards.
Think you're ready?
If you think you’re ready to start speculating why not start with us today? There is an old phrase that says you have to speculate to accumulate so if you are in the business of making more money the only way to do it is to start speculating more.
To get started the first thing you need to do is create an Axi account, next just fund your account and start executing your speculation strategy. It’s as simple as that.
The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.
The trading journal is one of the most underrated tools in the world of trading. The task of keeping such a journal can seem tedious in the beginning, and most traders lack the patience and discipline to update it frequently.