What is Speculative trading?

The word speculation is commonly used in the trading industry and sometimes it takes up diverse connotations. However in the financial markets speculation refers to the act of carrying out a trade or a transaction, which could potentially lead to either a profit or a loss. The trader will inadvertently believe that the probability of making a gain is considerable, and it should offset the possible risk of suffering a loss.

Speculative trading is not that simple as there are so many factors that could lead to price movements. While short-term speculation is generally preferred by most traders, others will opt for longer timeframes.

Currency speculation revolves around speculation on the changes in the currency exchange rates, and hence the trader will be hoping that when he purchases a currency it will gain in value, so as to be sold later on at a profit.

Sometimes speculating is thought to be merely investing, but in truth the two differ. Traders and investors will accept a calculated market risk when they open trades and try to make a profit when there are price changes in the assets which they are buying and selling. The main difference between investing and speculating lies in the among of risk that the investor undertakes.

When the money being spent is expected to lead to a rise in value, it is a form of investing. On the other hand if the investment seems to have a high probability of failing, then it becomes a speculation. Many traders develop a strategy which allows them to work their way to generate profits with the decisions that they make. Often such a strategy takes a considerable time to be developed. An example of such a strategy is arbitrage. Arbitrage strategies are generally used by institutional investors as they help to reduce risk considerably. Arbitrage refers to the attempt to make a profit from the difference in price of an asset in two or more markets. Hence one will buy the asset in a market at a low price, and then move on to sell it in a different market to make a profit. Generally the price differences are quite small.

Speculation does not require large amounts of capital and it can be carried out in most markets. However, unlike arbitrage there is a greater possibility of suffering a loss. Speculation in the Forex market is often considered to be quite similar to hedging where one buys and sells a currency with the aim of protecting against significant market moves.

There are different types of speculative traders, namely:

- Scalpers, traders who focus on making small profits over short periods. Scalpers sometimes place dozens of trades per day, and they tend to collect small profits from each one. Trades sometimes last only a few minutes.

- Day traders similar to scalping, but the timeframes are longer. Trades normally last a few hours, and positions are normally closed by the end of the trading day.

- Swing traders tend to hold a position for a number of days or even a few weeks.

Speculative trading is best complemented by stop loss orders and price in action trading so as to have some level of protection against substantial losses. Pattern trading is also common where one tries to identify price patterns to pinpoint opportunities in the market.