It is very easy to look at stock markets around the world and assume that volatile share prices inject a degree of gambling into the investment world. It is generally those who do not participate in stock market investments who use the term gambling because when you dig down a little deeper there is so much more to investing. There are occasions where you can “gamble” on short-term price movements but investing should be seen as a long-term activity.
Short-term volatility
As we touched on above, short-term volatility can give the impression that investing in stocks and shares is something of a gamble. The fact that you should do research and monitor shares very closely does to a great degree reduce the gambling tag but the fact remains fundamentals do not always dictate short-term price volatility. If stock markets around the world are buoyant or depressed then ALL share prices will be impacted to some degree. However, if you notice the trends of stock markets around the world they will very quickly correct overbought and oversold positions. Think of it like an elastic band, if it is overstretched to the left or to the right it will eventually snap back into place.
Fundamentals will always reign
The medium to long-term performance of any share price will be dictated by the underlying fundamentals and the prospects for the company. There is a general consensus that stock markets tend to look nine months in advance so a share price today is potentially taking into account nine months of trading. If you look more long-term, even if the prospects for a company were excellent, there is a greater risk that something could happen to derail the potential for the future. This is where your risk/reward ratio comes into play and you need to weigh up whether the potential rewards reflect the greater risk.
Derivatives
Derivatives are seen by many people as a form of gambling because of the gearing effect they offer. The truth is that used correctly derivatives can also be used as an insurance policy protecting the value of a portfolio in the short to medium term. When you put together those looking to “gamble” using derivatives, and those using derivatives as an insurance policy, this introduces extremely high liquidity and efficient markets. So, if you want to gamble there are many derivatives out there which offer potentially higher rewards but with a greater degree of risk.
Long-term investment
Many people see their stock market portfolio as their pension fund of the future and while a percentage of these funds may well be put aside for more “speculative” investments the vast majority will likely be invested on a long-term basis. There is nothing wrong in taking advantage of “special situations” but if you are looking to depend upon your portfolio income/capital in the future then you will need to take a more conservative approach. The degree of this conservative approach will depend upon your personal financial situation, your dependents and most importantly your age.