Speculative trading is a strategy which is high risk but can generate high reward. This differs to investing where asset classes are bought and held long term. Speculative traders may only hold the asset for a short period of time and sell the position once the speculator thinks it time to crystalise profits.
Definition
Speculative traders take high risk positions in assets which have the potential to generate very high returns. These investments also have the probability of generating very high losses as well. Unlike long term investments, speculators do not research on the fundamental details on these assets, they are entering the position with the objective of making money from a significant price appreciation. Unlike investing where an investor needs to take a long position of an asset, speculators can also take a short position of an asset if they think the price will fall. Short selling which is also a speculative strategy.
Examples of speculative products
Cryptocurrency – Cryptocurrencies are speculative investments as the price for this asset can appreciate significantly in one day but it can also depreciate enormously in one day. These are very high risk investments but a lot have been very profitable for some investors who bought these investments early enough.
Derivatives such as futures and options- Derivatives can be used to hedge positions so if the underlying security of the derivative goes against the investor, futures and options can be used as insurance to protect their positions. However, speculators take on derivative positions to make a profit by making predictions on where they think prices will head in the short term.
Angel investing – These are speculative investments where an individual provides capital to startup companies. These are highly speculative investments as these companies are in the beginning phases of growth and there is a high chance of failure. If however the startup does well, this can potentially produce a high return to the speculator.
Foreign Currency -The foreign currency market or forex market is a speculative investment as these are very volatile markets. Forex traders who trade on a margin are taking on even more risk. These speculators trade currency pairs to exploit price movements with the objective to make a profit from short term trading.
Derivatives such as futures and options- Derivatives can be used to hedge positions so if the underlying security of the derivative goes against the investor, futures and options can be used as insurance to protect their positions. However, speculators take on derivative positions to make a profit by making predictions on where they think prices will head in the short term.
Small capitalization stocks – Small capitalization stocks can be speculative investments as small cap stocks tend to not be very financially robust as they are in the beginning stages of growth. They may not even be making money. There is also a higher chance of bankruptcy with these smaller cap stocks. Speculators buys these stocks predicting the share price will have an enormous upside and sell the position once it reaches their target.
Profile of a speculative trader
Speculative traders have a high risk profile. They are comfortable with taking highly risky positions which have the potential to be big losses. These risks are undertaken as there is a potential to generate very high returns. These traders have short term time horizons. They usually exit a position sometimes within a day, weeks or months.
Lauren Hua is a private client adviser at Fairmont Equities.
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