What Are the Advantages and Disadvantages of Speculative Trading?

What Are the Advantages and Disadvantages of Speculative Trading?

Reading time: 6 minutes

Unlike investing, which focusses more on the longer-term picture and often incorporates in-depth analysis of companies and the economy, speculative trading prioritises the shorter-term picture, capitalising on minor price fluctuations and is more suited to day trading and scalping trading styles. It should be noted that any form of speculation entails assuming risk, whereas hedging involves transferring risk.

Speculative trading includes searching for overvalued and undervalued securities using two primary forms of analysis: fundamental and technical analysis. Aside from the duration of holding times and risk exposure, this is similar to investing. 

For directional traders, the idea of speculative trading is simple: buy low and sell high for long (buy) positions and sell high and buy low for short (sell) positions in various markets that offer an appropriate combination of liquidity and volatility. Market participants tend to focus on financial instruments, such as Stocks, Currencies, Bonds, Commodities, and Cryptocurrencies.

Like any form of investment, it is vitally important to understand that speculative trading carries advantages and disadvantages.

Advantages of Speculative Trading

• Level of Risk

One of the major advantages of short-term speculative activity is the ability to control risk.

Long-term investment strategies generally entail holding positions in the market over long durations, thus more susceptible to market crashes and shocks that can adversely affect one’s investment portfolio. A short-term approach, on the other hand, seldom carries overnight risk. This means a short-term speculative trader is regularly done for the day at the close of their session and if a market shock were to occur overnight or over the weekend, speculators would sidestep this move, while an investor would not.

It is recommended that traders – day traders and scalpers – adhere to a solid risk management strategy, including protective stop-loss orders.

• Control

Unlike investors who invest in the stock market using, say, a buy-and-hold strategy (which can involve holding their positions open for years), speculative traders can enter and exit the markets swiftly, taking advantage of any high-probability trading opportunities that may be present.

• Potential for High Returns

If you’re a skilled trader, generating sizeable returns is possible. However, it must be noted that these traders, who seem to pull money out of the markets at will, have honed their craft over years of study and trading experience.

Speak to any experienced profitable trader, and they will tell you that they have likely focussed on a handful of core components to achieve their success, including understanding the trading mindset, the need for positive expectancy (an edge), and the need for sound risk management.

Disadvantages of Speculative Trading

• Level of Risk

While speculative trading offers the advantage of not continuously being in the market, it does carry a high risk of loss, particularly for those who overleverage their trading accounts in volatile market conditions. Unfortunately, this can result in margin calls and account ruin for some.

• Difficulty Level

It is no secret that short-term trading in the financial markets has its challenges. Many rely on a combination of technical and fundamental analysis to guide their day-to-day trading decisions, and while some do achieve long-term success, many struggle. Their lack of success is due to various things, such as trading strategies, risk and money management, and education.

• Emotions

Speculative trading, especially for uninformed traders, can be an emotionally taxing endeavour. Most focus on being right; most do not accept that losses and being wrong are a large part of the trading business. No one knows the outcome of any individual trade (that is impossible), but many professional traders know that over a large enough sample of trades, their edge allows them to profit in the long term. So, for example, if your strategy has a 60% win ratio and provides a 1:2 risk/reward ratio, professional traders know that, say, over 100 trades, 60 of them are likely to be winners and 40 losers.

FAQs:

1. What is speculative trading?

Speculative trading is a process in which traders target short-term price fluctuations to profit from various asset classes.

2. What are the advantages of speculative trading?

Control and flexibility are a key advantage of speculative trading.

3. What are the disadvantages of speculative trading?

Speculative trading is challenging to become proficient in, and mastering it requires a unique skill set, including understanding the need for an edge, risk management, and emotional control.

4. Where can I learn more?

As communicated in the article, learning to trade successfully cannot be achieved on a weekend course. While the right course will be helpful, it is ultimately down to you to find what is right for you and then begin building a trading strategy around your preferences. Some prefer short-term scalping news events, while some favour a technical strategy that is centred on key levels of support and resistance.

Consider checking out the FP Markets Academy for more information on trading and investing. You may also want to head to the Traders Hub, where our in-house analysts deliver market analysis daily and weekly.