I’m currently reading Reminiscences of a Stock Operator by Edwin Lefèvre, which tells the fascinating story of the legendary trader and speculator Jesse Livermore (1877 - 1940). He started trading in 1892 at the age of 15 and later in his career he became one of the wealthiest persons alive. Although, when he ended his days with a Colt at age 63, his liabilities were much greater than his assets.

The first edition of the book came out in 1923 and I’m not entirely sure how much of the language and terminology has been updated for my 2007 edition, but everything sounds very familiar to anyone who has been engaged in some form of serious trading, be it day trading or swing trading.

In the book, Livermore operates through multiple broker houses and goes long and short on both stocks and commodities. He works with entire lists (equivalent to modern indexes) and uses leverage via margins. He watches the ticker tape and transmits various order types (market orders, limit orders, and stop-loss orders) over the wire. Sounds pretty familiar, right?

What struck me is that Livermore consistently calls his trading activities speculation (not investing) and he also frequently calls himself and his fellow traders speculators. Never once does he use the term investor.

I think that’s accurate and indeed, speculating is not the same things as investing. This is how Investopedia defines a speculator:

A speculator utilizes strategies and typically a shorter time frame in an attempt to outperform traditional longer-term investors. Speculators take on risk, especially with respect to anticipating future price movements, in the hope of making gains that are large enough to offset the risk.

For comparison, here’s Investopedia’s definition of an investor:

An investor is any person or other entity (such as a firm or mutual fund) who commits capital with the expectation of receiving financial returns. Investors rely on different financial instruments to earn a rate of return and accomplish important financial objectives like building retirement savings, funding a college education, or merely accumulating additional wealth over time.

Just by reading the definitions above one gets the impression that the main difference is the time frame. Whereas investors look to get a return on their committed capital over a longer time frame, speculators work with much shorter time frames.

But there’s also the relationship between risk and reward to be considered. I’m not sure how authoritative Investopedia is on these matters, but they go on to explain that “the primary difference between investing and speculating is the amount of risk undertaken. High-risk speculation is typically akin to gambling, whereas lower-risk investing uses a basis of fundamentals and analysis”.

Because gambling is usually frowned upon, many people will insist on portraying themselves as investors. They get bad vibes when thinking about speculation or betting and believe that it’s much more socially acceptable being seen as an investor, asset manager, fiduciary, trustee, or whatnot.

I don’t think there’s anything wrong in being a trader or a speculator. A person can be wildly successful as a speculator, as Livermore and countless other traders have proven. Yes, the risks are typically much higher and sometimes you can lose everything, even your life. In order to be successful you need the the right skills, the right brain, and a strong stomach. I didn’t have the stomach for it. Probably didn’t have the right kind of brain either.

In order to have functioning markets, we need both long-term investors and short-term speculators. Speculators play an important role by absorbing excess risk and providing much needed liquidity in the market by buying and selling when other investors don't participate.

I actually disagree to some extent with the traditional differentiation between speculating and investing. I think many people (and firms) who call themselves investors are in fact speculators. The case is clear if you have someone who just picks some stocks and hopes that they will go up. Sure, you can do fundamental analysis and form a strong “informed” opinion, but essentially you’re just placing bets. I would argue that the same is true for a larger buy-and-hold investor with a globally diversified portfolio. I don’t think global diversification helps much in today’s connected world, and in essence this investor is just placing a bigger bet that the markets (or rather the global economy) will continue to go up over a longer period of time.

Real investors, in my opinion, are the ones who actually work with the assets they’ve bought in order to increase their value. Examples would include renovating or developing property, such as real estate, or actively managing a portfolio company, as is customary in private equity and venture capital investing.

Now that is of course something that not all can do, or even should do. We need efficient mechanisms in the financial system for transferring surplus capital to projects where that capital is needed. Hence, we need both investors and speculators and they are both equally important in the markets. And if somebody calls you a speculator, you shouldn’t mind.