Should you speculate in the stock market?
Q: My broker has been telling me to buy a penny stock, which has already increased more than three folds since last month. I was told that the stock could go up higher in the next few days as more investors pour in support. Should I gamble my savings now and join the crowd? —Mia Sarah Maat by email
A: Some people have the wrong impression that when you invest in the stock market, it is like gambling your money in the casino. While there are apparent similarities between the two, investing in stocks is based on research while gambling is based on luck. Investing focuses on long-term gains while gambling emphasizes short-term gratification.
If you are buying stocks by following your emotions in the hope that you can take profit immediately without understanding the fundamentals of the company, you may not be considered an investor but a gambler.
To become an investor in the strictest sense of the word is to buy stocks with the intention of holding them for the long-term in order to collect dividends and achieve capital appreciation. As a long-term investor, you would avoid trading in and out of the stock market unless there is a need to change your position when there are changes in the fundamentals that threaten the long-term outlook of your investments, for example, changes in business strategies that may affect profitability of the company or permanent cuts in dividends.
But if your aim is to invest like a gambler by buying undervalued stock that promises to be potential multiple bagger in few weeks or months, you could be considered a speculator.
Speculation in stocks has taken negative connotation in the past because investors involved in this activity have been associated with investing in speculative stocks that are fundamentally questionable and highly risky. Speculating can also mean investing in a blue chip stock that is about to announce a joint venture with a global company, or profitable second-liner that is emerging to become a dominant industry player in few years.
In other words, speculative investing can be profitable if you combine the research discipline of the investor and the risk taking approach of the gambler. It takes certain skills to speculate successfully.
Here are some of the guidelines that you can follow:
- Do not buy stocks based on tips. You may get some hot tips to buy a certain stock from your social media groups or broker speculating that something is about to happen to this company. Try to avoid buying on tips because either you may be already late in the game or the tip may turn out to be false.
Instead of acting on the tip immediately, use it as your potential lead to validate the information further and if found to be viable, try to project the probable impact on the stock price before you decide to speculate.
- Do your homework. Sometimes you don’t have to wait for people to give you leads. You can initiate your own research to pick your stocks. Your focus can be on growth or value stocks. For example, you can invest in stocks that are trading at relatively high P/E ratios because you have researched that their growth story can sustain the earnings growth in the future.
You can also do value investing. Find stocks that are trading grossly below their market value by P/E ratio or book value. Review the financials and assess if the stock is worthy to accumulate now while the stock price is low.
- Do not trade at all times. There are times when there are no profitable opportunities in the market. Do not force yourself by speculating on small positions for quick profits. The more you trade, the higher the risks that you will lose money.
If you feel like you are gambling more than investing, try to stop trading and take a vacation. Taking a break from trading can help you de-stress and freshen your mind. You will be more productive and psychologically more focused when you come back to trading after taking a vacation.
- Do market timing. You can use charting techniques to anticipate the next big move of a stock by looking at the patterns. Check the volume activity of the stock. Is the market accumulating or distributing? If the share price is going up on rising volume, this could mean that the market is accumulating and you can speculate that something positive is happening soon.
If the share price is going up on declining volume, market players could be selling by taking opportunity to unload their holdings at a higher price.
You can speculate that there must be some bad news from the company that is coming out soon and this will lead the share price to fall.
- Do cut your losses quickly, if you have speculated on the wrong bet. Accept that you made a mistake and move on. Ideally, you must limit your losses up to 10 percent of your investment.
This will give you a chance to recover your losses with almost the same percentage when you invest in your next trade. The bigger your losses, the harder it is for you to recover. For example, if your investment lost 50 percent, you will need to earn 100 percent on your next trade in order to recover your losses.
It is all right to speculate in the market for as long as you do it intelligently.
There are always opportunities to make money in the stock market, but knowing how to manage your risks by equipping yourself with the right skills and education is one sure way to succeed in speculative investing.
Henry Ong is a Registered Financial Planner of RFP Philippines. Stock data and tools provided by Technistock. To learn more about stock analysis and value investing, attend the 8th Accredited Financial Analyst (AFA) program this June 4-July 9. To register, e-mail [email protected] or text <name><e-mail> <AFA> at 0917-9689774.
