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What Books More Profit For You - Speculation, Hedging or Arbitraging?

HomeWhat Books More Profit For You – Speculation, Hedging or Arbitraging?

Investments are done only to make profit, no need to re-iterate this here. But the types of investments impacts the profits you book for a given period of time. There are many factors that need to be considered when you plan your investments, some of which can be illustrated as: your risk profile, volatility of market and the sector where you are investing, average rate of return, liquidity in the market and most importantly the amount of time you are willing to give your investments to grow. These are but only the major factors among the many other risks. So, while planning your investments and picking the right instruments, one needs to take such a position that will benefit him or her in making a long term investment plan.

There are many strategies that one can implement in the stock markets

First strategy – Hedging in which you diversify your investments into multiple assets all of which do not move in tandem with the market. If the assets have a higher correlation coefficient then you should ideally revise them. For example, if you have picked a multibagger stock i.e. one that assures manifold returns over the initial investment value, then you can put your money into relatively safer options like Government bonds, etc. that fetch you assured returns. This way you hedge your position against the odds of an adverse future movement in the price of your stock.

Another strategy is speculation which is very risky. In this case, the investor typically tries to take advantage of the the price difference in a short span of time. In other words, he buys in a market hoping that the price of the share purchased would increase over a given (usually short period of time) and vice versa. Some investors also buy stocks at a lower price and are confident that the price is going to soar in future due to a management decision at which time they will sell the stock at higher value.

The third strategy is arbitraging where an investor tries to make risk-free gains by borrowing money for investments. This works by borrowing at a lower rate of interest and investing in such alternatives that can pay off a rate of interest higher than the borrowing rate. Only those with great business acumen or large market players get into this given the small margins to be earned. Whatever strategy you adopt, there is definitely a certain degree of risk. Irrespective of the approach you choose, it is most important that you follow it and not mix these styles of investing as that would lead to disastrous consequences for your portfolio. Further, you must be careful about the stocks (or the asset classes) on which you implement any of these strategies. As a genral rule, stay away from low quality stocks and bad asset classes.

About the Author

Rajat Sharma pictureRajat Sharma is a well known stock market analyst and commentator. He has covered Indian markets for over a decade and is regarded for consistently identifying early stage investment opportunities. Attorney by qualification, Rajat has done extensive work for improving corporate governance and disclosure standards.