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Nobel Prize-winning Russian physiologist Ivan Pavlov is best-known for describing the relationship between stimulus and response through his simple experiments with a bell and a dog.

What Pavlov found was that by ringing a bell every time he offered a dog food, the ringing sound would eventually provoke salivation in the poor mutt, even if he didn't offer it food.

In a similar way, many novice investors view the sharemarket according to their learned responses. If you've only ever held shares in Ryman Healthcare RYN or Metlifecare MET over the past 10 years, for example, you may well salivate at the mere mention of retirement village stocks.

On the other hand, if your first dabble in shares was to take a punt on a rumour that a mining exploration company would strike the mother lode, you may well regard the sharemarket as little more than a casino. And the bell ringing in your ear would no doubt sound very different!

The reality for most people who have been around the market for a while is generally somewhere in between.

While there are numerous ways of approaching the sharemarket, and while the lines between different approaches can easily become blurred, it's useful to draw an early distinction between two approaches: long-term investment and speculative trading.

American Benjamin Graham, a clear-thinking investment analyst who wrote the legendary texts Security Analysis and The Intelligent Investor, is known for his commonsense investment principles, many of which remain valid today.

Here's how he describes the difference between the two: "An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting those requirements are speculative." This distinction is worth considering every time you invest in shares.

Three Types of Shares, Three Layers of Risk
Before exploring these two approaches, we'll divide the sharemarket into three manageable chunks to help clarify the distinction between long-term investment and speculative trading.

Within the sharemarket, some companies are more likely to produce a more consistent, reasonable return than others. That doesn't necessarily mean that they will produce a higher return and, in many cases, they won't. But it does mean that the chances of them producing a shocker of a result or a surprise downward spiral are regarded as lower, although there are no guarantees.

Our three manageable chunks are ranked according to their safety and reliability as longer-term investments.

Blue-chip companies tend to be big household names like Contact Energy CEN or Fletcher Building FBU. These companies have usually been in business for many years, have track records of rising annual profits, uninterrupted records of paying dividends, and strong and trustworthy management.

Second-line stocks are sometimes (but by no means always) the blue chips of tomorrow. A second-liner may not have the vintage or first-class track record of a blue chip, possibly because it is simply younger, or it may have a fierce competitor that prevents it from becoming market leader in a particular business franchise. While they are often riskier than blue chips, second-liners have the potential for some heart-thumping movements, but they are still generally far from speculative. Good second-line stocks are usually earning profits and paying dividends or, if mining stocks, will own an economically viable resource.

Speculative is just as it sounds. 'Specs' or 'penny dreadful' stocks tend to have little in the way of track record, and plenty in the way of hype and blue sky. Typical specs include mining and oil exploration companies, 'concept' companies that may have an innovative and potentially revolutionary idea and, more recently, technology stocks.

Speculative share buying rests on the premise that "from tiny acorns, mighty oak trees grow" � but always bear in mind that plenty also go to seed. Microsoft was once a speculative stock, but it managed to deliver a compound annual return of more than 50.0 percent between the mid-1980s and 2000, turning it into one of the world's leading blue-chips. It is literally bigger than the economies of most countries.

Big, successful companies all start somewhere, and a speculative stock with a winning idea will often generate far higher gains than a blue-chip or a second-liner. It's just that the risks among stocks like this are much higher, too. For every Microsoft, there are literally hundreds of entrepreneurs � some of them already listed, some not � with mountains of debt and few reserves of hope.

Concentrating on a search for the next Microsoft, however, may bring a portfolio back to average overall returns by 'would be' and 'gunna' stocks that have bitten the dust.

Armed with this knowledge, how do our three share classes fit in with the two main types of investment approach that we identified earlier: long-term investment, and speculative trading?

While in practice the lines between the two approaches are blurred and most investors will almost certainly try both at some stage, it's a good discipline to start by thinking of them as unrelated.