When you first start exploring concepts like investment and stock trading, you’ll quickly discover there are many different ways to spend your money. Over time, you’ll develop a specific strategy based on what you learn about the industry and market. However, initially, you’ll need to do some research to determine what kind of strategies are going to be most effective for you.
Speculation and arbitrage are two financial strategies, each with their own degree of risk. Arbitrage techniques are more common among institutional investors and hedge fund owners. This plan comes with a limited degree of risk and involves buying an asset from one market and selling it for a slightly higher price in a different environment. Alternatively, speculation is more common among smaller investors, because it doesn’t require a huge investment base. Let’s take a close look at the two options.
Who Uses Speculation?
Speculation is a common practice among those who purchase penny stocks and smaller investment opportunities. In the penny stock market, for instance, speculative investments would involve purchasing assets based on the information you have a specific market, the company offering the share, or other valuable information. Anyone can get involved with this kind of speculation.
The whole point of the trading strategy is that you collect as much information as you can about what you’re buying or selling, then use that information to boost your chances of success in your specific market. Even a person purchasing a house with the purpose of selling it is involved in speculation, because they’re assuming the price of the home will go up when the time comes to sell. Without speculation, the stock market simply couldn’t thrive like it does today. Without this short-term buying and selling strategy, there would be no liquidity, and people wouldn’t have an opportunity to move positions whenever they wanted, buying and selling according to specific plans.
Who Uses Arbitrage
Unlike speculation, which is open to anyone, arbitrage is more common among big spenders, larger brands, and people in the financial market who tend to move a lot of assets quickly. This strategy works by allowing companies to buy an asset in one market and sell it in another for a chance of making a profit. The strategy works because of inefficiencies in markets.
For instance, you could purchase an asset in the New York exchange, and sell it in the London exchange to make money on the different values between the two solutions. The process is very straightforward. Arbitrageurs often enter larger positions since they attempt to profit from smaller differences in prices. These individuals may also get involved with low-cost penny stocks, because these allow these groups to make massive purchases and sales at speed.
Crucially, the biggest difference between this strategy and speculation is that there are limitations on who can get involved. You’ll need a pretty large initial investment for arbitrage, whereas speculative environments can happen in any environment, without the demand to spend a lot of money. As with all kinds of trading, it will be up to you to determine what works best for your strategy.
Photo by Nicholas Cappello on Unsplash