Arbitrage vs Speculation
Traders in today’s marketplace continuously use various tactics to obtain higher levels of return through special methods of trading. Arbitrage and speculation are two concepts focused on making such a profit. The aim of both arbitrage and speculation is to make some form of profit even though the techniques used are quite different to each other. The following article provides a clear overview of each type of technique and outlines their very distinct techniques of making a profit.
What is Arbitrage?
Arbitrage is where a trader will simultaneously purchase and sell an asset with hopes to make a profit from the differences in the price levels of the asset that is bought and the asset that is being sold. It must be kept in mind that the assets are bought and sold off different market places; which is the reason for the differences in the price levels. The reason as to why there are differences in price levels in different markets is because of the market inefficiencies; where even though the conditions in one market place have resulted in a change, in price levels, as this information has not yet impacted the other market place, the price levels remain different. A trader looking to make a profit can use these market inefficiencies to their advantage by merely buying the asset at a cheaper price from one market and selling it off at a higher price afterwards to make an arbitrage profit.
What is Speculation?
Speculation, on the other hand, refers to a form of financial gamble where the trader takes a risk in which he may obtain large financial gains or losses. Since the trader has the opportunity to both lose and gain it is considered to be a form of gamble. However, the speculator is motivated to take such large financial risks because the possibility of making a huge financial gain is larger and more probable than making a loss. Speculation is done by trading instruments such as stocks, bonds, currency, commodities, and derivatives, and a speculator looks to make a profit through the rising and falling of the prices in these assets. For example, a trader may attempt to make a profit by taking by shorting stock, thereby attempting to make a profit through a fall in price. If the price falls the trader benefits, and if not, he may suffer a large loss.
Arbitrage vs Speculation
Speculation and arbitrage are both techniques used by traders, to make larger profits. However, as discussed the method in which each technique is used differs. Arbitrage traders take lower levels of risk, and benefit from the natural market inconsistencies by buying at a lower price from one market and selling at a higher price at another market. Speculators make a profit by taking higher levels of risk, through price changes by making trades and anticipating their outcome.
Summary:
What is the difference between Arbitrage and Speculation?
• The aim of both arbitrage and speculation is to make some form of profit even though the techniques used are quite different to each other.
• Arbitrage traders take lower levels of risk, and benefit from the natural market inconsistencies by buying at a lower price from one market and selling at a higher price at another market.
• Speculation is done by trading instruments such as stocks, bonds, currency, commodities, and derivatives, and a speculator looks to make a profit through the rising and falling of the prices in these assets.