There are significant differences between saving, investing, speculating and gambling, and chances are you will do some of all them before reaching retirement. Saving involves putting your money into a safe, secure place, such as a bank. Your savings dollars won't earn much, but your risk of loss is practically non-existent. Gambling is just the opposite. You might get a big payoff, but you are probably going to lose your money when you gamble. Investing and speculating are somewhere in between saving and gambling, and you can do both in the stock market.
You can apply a number of speculation techniques when trading stocks. Speculation is a form of investing that involves taking significantly larger risks in exchange for anticipated higher gains. Speculation does not depend on the roll of a dice, the flip of a coin or the luck of the draw. It involves making an informed investment decision that carries with it the significant risk of loss. You should never speculate with money that you cannot afford to lose.
Perhaps you believe the price of a particular stock is about to have a sharp price increase, and you want to acquire more shares than you can afford to purchase outright. You can speculate on the stock by buying it on margin. Margin is a form of borrowing. You borrow money from an investments broker to purchase the stock using the stock in your account, which will include the stock you are purchasing, as collateral for the loan. You can double your purchasing power by using buying on margin, which doubles your potential profit. On the down side, you will have to pay interest on the amount you borrow, and if the stock drops in price, you risk double the loss. If the stock price drops significantly, your broker may issue a margin call, requiring you to deposit additional money into your account.
You can speculate on the stock market by trading options. Options give your the right to buy or sell a particular stock at a set price for a specific amount of time, without giving you stock ownership. You participate in any gains produced by the movement of stock price, at a fraction of the cost of buying the actual stock. An option's value is divided into two parts; its time value and its intrinsic value. A call option on a stock whose price below the strike price has no intrinsic value. Its time value is based on how much time remains before it expires. Options cease to exist once they reach their expiration date. If your option reaches its expiration date with no intrinsic value it will become worthless. You risk 100 percent of your investment.
Hedging is a common practice for stock speculators. It is a technique designed to reduce the risk of an inherently risky investment by making an equal investment in the opposite direction. Perhaps XYZ stock is getting ready to announce a new wonder drug. You think XYZ stock is going to skyrocket, so you buy 100 shares. It is also possible that the FDA will not approve the new drug, and all of XYZ's massive investment in developing the drug will result in a record loss that could drive the price of its stock into the ground. You can hedge your stock purchase by also buying a put option on the stock, which allows you to sell the stock at a fixed price. If the stock price goes through the roof, you make money on your stock purchase, and you are only out the premium you paid for the put option. If the price of the stock drops like a rock, you can exercise your put and sell the stock for the strike price, effectively limiting your loss.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.