Tuesday, January 25, 2011

Speculation drives human progress

Speculation, in all its forms, is what drives human progress. This is the core message behind Michael Bigger's recent post, "The Desire to Speculate".

An excerpt from Michael's essay:

It is said that the desire to speculate is very strong in the American people. That is why our country has made greater progress than any other country in the world, because
progress is the result of speculation. We are not referring merely to stock speculations, but to the word in its broadest sense. Every new undertaking is a speculation.

An inventor speculates on what he is going to invent. Often such speculations result in losses, because many inventors, or would-be-inventors, never accomplish very much. They spend their money, time, and efforts, and probably live years in poverty, and then if the invention is not profitable, they are heavy losers.

It is the same thing with every new business. It is purely a speculation..."

This is a great point, and one that is greatly misunderstood by some ignorant politicians, journalists, and everyday people who refer to "speculators" as wicked people who somehow conspire to drive prices of shares or commodities higher or plunge them lower.

Any human activity that requires foresight and planning and the assumption of risk (of money or labor lost) is a form of speculation. Thomas Edison speculated with his toil and sweat as he sought to perfect and market yet another invention, never knowing for sure whether it would succeed or fail in the end.

Venture capitalists speculate with their partners' capital when they back a new technology firm or a startup that makes electric cars.

Traders may speculate with their own money (and emotional capital) that some catalysts will serve to send prices of share "x" or commodity "y" higher or lower in the days and months ahead.

In other words, we speculate when we imagine something new or create some new business or invention or vote with our dollars on future outcomes in the marketplace.

As Bernard Baruch famously pointed out, the word speculate comes from the Latin speculari, which means "to observe" or "to look (spy) out". This is the essence of speculation, to look out towards a great distance and try to observe future developments.

However, there are differences that separate the successful speculator from the wreckless gambler. As Michael mentions in his post, most people think of all the profit to be made in a speculative venture, instead of focusing on the risk of loss:

"...It does not pay to take big risks. That is true in stock speculating the same as in any other undertaking. Most speculators are keeping their minds all the time on the possibilities of profit and not thinking about the possibilities of losing.

There is an old saying, and we believe a very true one, that a man who speculates with the idea of getting rich quickly loses all his money quickly, but that the man who speculates with the idea of making a fair return on his money usually gets rich..."

Do you speculate with an eye towards big profits? How many of us dream of returns while neglecting the discipline of adhering to sound principles of risk management? What can we do to sharpen our judgement and improve our odds of success in any form of speculation, be it a new business venture or a stock trade?