Arbitrage vs Speculation

Podcast Duration: 05:34

Hi friends, and welcome to this podcast by Angel One.

Doston, kya aapne stock markets mein arbitrage aur speculation ke baare mein suna hai?

If you are someone who is always looking to expand your profits with your stock trading, then you must have come across these words.

So what are they, and what’s the difference between the two?

Chaliye dekhte hain, lekin uske pehle ye story suniye.

Doston Ravi was planning to invest in a new shopping mall that was opening up in his town. The company that was building the mall offered stakes in the venture, and he wanted to invest in it in the hopes of growth.

Do you see what is happening here? Ravi ke according mall ek profitable venture hai. Lekin do we know for sure, ki the mall will become a profitable business? We don’t. Lekin Ravi ke according it is true, and he is ready to place his money on it.

In other words Ravi was speculating.

But consider his friend Vishwas. Vishwas ek property khareedne jaa raha tha. Jab Ravi ne usse poocha, ki why was he buying a house on the outskirts of the town, Vishwas had a simple answer. Usne Ravi ko bataya, ki someone had already bought that house from him for 6 lacs more.

What Vishwas did is called arbitrage.

Doston aap arbitrage aur speculation ke beech ka main difference toh samajh gaye honge. Lekin how do these two strategies work in the stock market, or trading in general?

Let’s find out right away.

Pehle dekhte hain arbitrage.

Doston arbitrage is very simple. It basically refers to a kind of trade, jisme traders buy a security, and usko higher price par sell kar dete hain, lekin in a different market.

Sounds simple, safe and cool, right?

Now, let’s backtrack to speculation. So speculation is basically a short-term buying and selling strategy. For example, aap dekhte ho ki ek pharmaceutical company asia ke liye masks supply karne ki planning kar rahi hai. Looking at the current scenario, you realize ki is company ke stocks rise karne wale hain. So, you buy the stocks in the hopes of making a profit.

Speculation aur investment mein there is a very small difference. Speculation mein your ultimate motive is making high returns.

You see, the downside to speculation is that profits high hone ke alawa high losses ki kaafi probability bhi hoti hai. Iska matlab ye, ki speculation mein profit is the main driver of the trade, but risks of high losses is also high.

Doston is podcast mein hum arbitrage aur speculation ke beech back and forth move karne wale hain. Toh doston, keep your ears wide open! Coming back to arbitrage - we said arbitrage is safe and simple - toh why doesn’t everyone do it?

The reason is simple - they can’t. Let’s see why.

Doston do you know how arbitrage works? Arbitrage possible hota hai kyunki markets are inefficient. You already know ki prices supply aur demand se kaise affect hoti hain. Well, in theory.

In practice, supply badhne ya demand reduce hone se prices immediately fall aur rise nahi hoti. To see the effect of such changes, markets take time. Arbitrage traders is gap ko exploit karte hain.

Now, the problem is that agar koi security do markets mein alag alag rates par sell ho rahi hai, toh the difference is usually very small. Big price gaps fill up fast.

Iska matlab ye, ki making profits requires large trading volumes. Ab doston, this is not something retail investors can do, right?

That’s why, arbitrage is usually limited to big financial institutions, high net-worth individuals and businesses.

Now, coming back to speculation.

The good thing here is that anyone can make speculative trades. Mere aur aapke jaise retail investors, and big players alike - can engage in speculation. Now, the problem here is that speculative trading usually ek hunch ya assumption par based hoti hai - a trader expects the prices to rise and fall, and accordingly, woh apne trades place karte hain.

So speculative trading mein ek point par do sides ho sakte hain - those who think that the prices will fall, and those who think otherwise. It’s not that simple, there are nuances too. But basically, this is what brings liquidity to markets - speculative trading ke bina markets mein liquidity exist nahi kar sakti, aur traders would be limited to producers, buyers and sellers of a security.

So far so good. Speculation mein all kinds of securities are traded - currency, stocks, bonds, derivatives, you name it - speculative trading is at play in almost all securities we see around us.

So friends, this is the basic difference between arbitrage trading and speculative trading. Sounds cool, right? Markets mein investors use different types of strategies, and these are only two of them. Now arbitrage aur speculative trading - dono mein there are different strategies and techniques. Are you curious to find out what they are?

Then check out our other podcasts on these topics, or visit our website to explore the markets in depth!