Understand the Difference Between Arbitrage vs. Speculation

If it is an individual investor or a financial investment firm, their motto behind the investment is always to gain some profit within a particular time.

When these methods of investment are planned correctly, with estimating the precise outcome, they are called strategies. The strategy itself means to act in a way where you are aware of the desired outcome. To master these strategies you need a lot of skills such as dedication, patience, practice, courage to face losses, and many more. We must also not forget the amount of risk associated with our goal.

For example in a high jump athletic event, if the player misses out one second he may damage his leg or any body part, here the risk is of time and concentration. In the same way, consider a boxer, though he is good at punching, he must also learn to take punches, that's a risk involved for him in this field. So, no matter in what field you are there is always a degree of risk associated, sometimes you may even make the strongest strategy, but some unseen factors can break that strategy.

Coming to the point of what separates Arbitrage from Speculation. Both the terms are used as financial strategies, as discussed above both of them have their advantages and disadvantages. You should take into consideration that strategy with which you are comfortable and have mastered.

Before jumping right into the Arbitrage Vs. Speculation, you must know what those terms mean? When you are clear with the difference, pros, and cons, you will be able to decide which strategy will be best suited for you.

Arbitrage: Arbitrageurs buy an asset from market A at a lower price and sell it into market B at a higher price. Now you may think the reason behind the difference in the price in both the markets? It is because there are a lot of factors affecting the price of the asset, you can simply understand that those factors have affected market A, but its effect is not yet seen in market B or vice versa. They can earn profits from this price fluctuation in different markets.

Some new traders might think it is an easy way to earn the profit from the difference, but as discussed, there are various costs attached while trading, so you have to calculate the profit after deducting all such costs involved, otherwise, you may end up losing money instead of making a profit.

The practice of Arbitrage is commonly seen in financial investment companies and hedgers. As the amount of assets is very high, small traders do not use this strategy.

The traders use Arbitrage mostly in the financial market, they buy stock in US dollars and sell it on the London stock exchange in pounds, to get the exchange rate difference, please remember this should be done in the quickest way possible to avoid the losses.

Arbitrageurs invest the large positions because the profit gain is very small, so they can see some profit only if they have a huge amount of stock. Thus only huge investors and hedge funds use this strategy.

Speculation: Speculation is yet another strategy. The degree of risk attached with speculation strategy is very high. But still, the trader takes risks and trades using this strategy, because if the situation is favorable, then they can have a huge financial gain, or at worst a huge loss. Speculation strategy is applied to instruments such as stocks, currency, bonds, commodities, and derivatives. This is the process where the traders trade on the fall or rise of the price. Speculators based on their assumptions make a trade. It helps in maintaining liquidity in the market. It is not like arbitrage, where only a few can trade, instead small traders can also be the speculators and try their luck with speculating and ultimately resulting in profit.

Arbitrage Vs. Speculation

● As seen above both are the financial techniques used by traders.

● Arbitrageur has a lower amount of risk, while speculator faces a higher degree of risk.

● Arbitrage can be said as the difference in the price in different markets, while speculators earn from the price change of the commodity in a given period.

● The main goal of both strategies is same: earning profit.

● Arbitrageurs earn profit from the natural market inconsistency, while Speculators earn from falling and rising the prices of the same commodity.

Conclusion

We hope you are clear with the difference between them and the risk involved in both financial strategies. Your feedback and suggestions are welcomed in the comment box.

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