HOME

TheInfoList



OR:

In
finance Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of f ...
, speculation is the purchase of an asset (a
commodity In economics, a commodity is an economic good, usually a resource, that has full or substantial fungibility: that is, the market treats instances of the good as equivalent or nearly so with no regard to who produced them. The price of a co ...
, goods, or
real estate Real estate is property consisting of land and the buildings on it, along with its natural resources such as crops, minerals or water; immovable property of this nature; an interest vested in this (also) an item of real property, (more genera ...
) with the hope that it will become more valuable shortly. (It can also refer to
short sales In finance, being short in an asset means investing in such a way that the investor will profit if the value of the asset falls. This is the opposite of a more conventional " long" position, where the investor will profit if the value of the ...
in which the speculator hopes for a decline in value.) Many speculators pay little attention to the fundamental value of a security and instead focus purely on price movements. In principle, speculation can involve any tradable good or
financial instrument Financial instruments are monetary contracts between parties. They can be created, traded, modified and settled. They can be cash (currency), evidence of an ownership interest in an entity or a contractual right to receive or deliver in the form ...
. Speculators are particularly common in the markets for stocks, bonds, commodity futures, currencies,
fine art In European academic traditions, fine art is developed primarily for aesthetics or creative expression, distinguishing it from decorative art or applied art, which also has to serve some practical function, such as pottery or most metalwor ...
, collectibles,
real estate Real estate is property consisting of land and the buildings on it, along with its natural resources such as crops, minerals or water; immovable property of this nature; an interest vested in this (also) an item of real property, (more genera ...
, and derivatives. Speculators play one of four primary roles in financial markets, along with hedgers, who engage in transactions to offset some other pre-existing risk,
arbitrage In economics and finance, arbitrage (, ) is the practice of taking advantage of a difference in prices in two or more markets; striking a combination of matching deals to capitalise on the difference, the profit being the difference between t ...
us who seek to profit from situations where fungible instruments trade at different prices in different market segments, and investors who seek profit through long-term ownership of an instrument's underlying attributes.


History

With the appearance of the
stock ticker machine Ticker tape was the earliest electrical dedicated financial communications medium, transmitting stock price information over telegraph lines, in use from around 1870 through 1970. It consisted of a paper strip that ran through a machine called ...
in 1867, which removed the need for traders to be physically present on the stock exchange floor, stock speculation underwent a dramatic expansion through the end of the 1920s. The number of shareholders increased, perhaps, from in 1900 to in 1932..


Vs. investment

The view of what distinguishes investment from speculation and speculation from excessive speculation varies widely among pundits, legislators and academics. Some sources note that speculation is simply a higher-risk form of investment. Others define speculation more narrowly as positions not characterized as hedging. The U.S. Commodity Futures Trading Commission defines a speculator as "a trader who does not hedge, but who trades with the objective of achieving profits through the successful anticipation of price movements". The agency emphasizes that speculators serve important market functions, but defines excessive speculation as harmful to the proper functioning of futures markets. Via
Benjamin Graham Benjamin Graham (; né Grossbaum; May 9, 1894 – September 21, 1976) was a British-born American economist, professor and investor. He is widely known as the "father of value investing", and wrote two of the founding texts in neoclassical inves ...
in ''
The Intelligent Investor ''The Intelligent Investor'' by Benjamin Graham, first published in 1949, is a widely acclaimed book on value investing. The book provides strategies on how to successfully use value investing in the stock market. Historically, the book has been o ...
'', the prototypical defensive investor is "...one interested chiefly in safety plus freedom from bother". He admits, however, that "...some speculation is necessary and unavoidable, for, in many common-stock situations, there are substantial possibilities of both profit and loss, and the risks therein must be assumed by someone." Thus, many long-term investors, even those who buy and hold for decades, may be classified as speculators, excepting only the rare few who are primarily motivated by income or safety of principal and not eventually selling at a profit.


Economic benefits


Sustainable consumption level

Nicholas Kaldor Nicholas Kaldor, Baron Kaldor (12 May 1908 – 30 September 1986), born Káldor Miklós, was a Cambridge economist in the post-war period. He developed the "compensation" criteria called Kaldor–Hicks efficiency for welfare comparisons (1939), ...
has long recognized the price-stabilizing role of speculators, who tend to even out "price-fluctuations due to changes in the conditions of demand or supply", by possessing "better than average foresight". This view was later echoed by the speculator Victor Niederhoffer, in "The Speculator as Hero", who describes the benefits of speculation:
Let's consider some of the principles that explain the causes of shortages and surpluses and the role of speculators. When a harvest is too small to satisfy consumption at its normal rate, speculators come in, hoping to profit from the scarcity by buying. Their purchases raise the price, thereby checking consumption so that the smaller supply will last longer. Producers encouraged by the high price further lessen the shortage by growing or importing to reduce the shortage. On the other side, when the price is higher than the speculators think the facts warrant, they sell. This reduces prices, encouraging consumption and exports and helping to reduce the surplus.
Another service provided by speculators to a market is that by risking their own
capital Capital may refer to: Common uses * Capital city, a municipality of primary status ** List of national capital cities * Capital letter, an upper-case letter Economics and social sciences * Capital (economics), the durable produced goods used fo ...
in the hope of profit, they add liquidity to the market and make it easier or even possible for others to offset
risk In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty about the effects/implications of an activity with respect to something that humans value (such as health, well-being, wealth, property or the environm ...
, including those who may be classified as hedgers and arbitrageurs.


Market liquidity and efficiency

If any market, such as pork bellies, had no speculators, only producers (hog farmers) and consumers (butchers, etc.) would participate. With fewer players in the market, there would be a larger spread between the current bid and the asking price of pork bellies. Any new entrant in the market who wanted to trade pork bellies would be forced to accept this illiquid market and might trade at market prices with large bid–ask spreads or even face difficulty finding a co-party to buy or sell to. By contrast, a
commodity In economics, a commodity is an economic good, usually a resource, that has full or substantial fungibility: that is, the market treats instances of the good as equivalent or nearly so with no regard to who produced them. The price of a co ...
speculator may profit from the difference in the spread and, in competition with other speculators, reduce the spread. Some schools of thought argue that speculators increase the liquidity in a market, and therefore promote an efficient market.http://chicagofed.org/digital_assets/publications/understanding_derivatives/understanding_derivatives_chapter_1_derivatives_overview.pdf This efficiency is difficult to achieve without speculators. Speculators take information and speculate on how it affects prices, producers and consumers, who may want to hedge their risks, needing counterparties if they could find each other without markets it certainly would happen as it would be cheaper. A very beneficial by-product of speculation for the economy is price discovery. On the other hand, as more speculators participate in a market, underlying real demand and supply can diminish compared to trading volume, and prices may become distorted.


Bearing risks

Speculators perform a risk-bearing role that can be beneficial to society. For example, a farmer might consider planting corn on unused
farmland Agricultural land is typically land ''devoted to'' agriculture, the systematic and controlled use of other forms of lifeparticularly the rearing of livestock and production of cropsto produce food for humans. It is generally synonymous with bo ...
. However, he might not want to do so because he is concerned that the price might fall too far by harvest time. By selling his crop in advance at a fixed price to a speculator, he can now hedge the price risk and plant the corn. Thus, speculators can increase production through their willingness to take on risk (not at the loss of profit).


Finding environmental and other risks

Speculative
hedge fund A hedge fund is a pooled investment fund that trades in relatively liquid assets and is able to make extensive use of more complex trading, portfolio-construction, and risk management techniques in an attempt to improve performance, such as ...
s that do fundamental analysis "are far more likely than other investors to try to identify a firm's off-balance-sheet exposures" including "environmental or social liabilities present in a market or company but not explicitly accounted for in traditional numeric valuation or mainstream investor analysis". Hence, they make the prices better reflect the true quality of operation of the firms.Unlikely heroes - Can hedge funds save the world? One pundit thinks so
The Economist, 16 February 2010


Shorting

Shorting may act as a "canary in a coal mine" to stop unsustainable practices earlier and thus reduce damages and form market bubbles.


Economic disadvantages


Winner's curse

Auctions are a method of squeezing out speculators from a transaction, but they may have their own perverse effects by the winner's curse. The winner's curse is, however, not very significant to markets with high liquidity for both buyers and sellers, as the auction for selling the product and the auction for buying the product occur simultaneously, and the two prices are separated only by a relatively small spread. That mechanism prevents the winner's curse phenomenon from causing mispricing to any degree greater than the spread.


Economic bubbles

Speculation is often associated with
economic bubble An economic bubble (also called a speculative bubble or a financial bubble) is a period when current asset prices greatly exceed their intrinsic valuation, being the valuation that the underlying long-term fundamentals justify. Bubbles can be c ...
s. A bubble occurs when the price for an asset exceeds its intrinsic value by a significant margin, although not all bubbles occur due to speculation.: "In a setting in which speculation is not possible, bubbles and crashes are observed. The results suggest that the departures from fundamental values are not caused by the lack of common knowledge of rationality leading to speculation, but rather by behavior that itself exhibits elements of irrationality." Speculative bubbles are characterized by rapid market expansion driven by word-of-mouth feedback loops, as initial rises in asset price attract new buyers and generate further inflation. The growth of the bubble is followed by a precipitous collapse fueled by the same phenomenon. Speculative bubbles are essentially social epidemics whose contagion is mediated by the structure of the market. Some economists link asset price movements within a bubble to fundamental economic factors such as cash flows and discount rates. In 1936,
John Maynard Keynes John Maynard Keynes, 1st Baron Keynes, ( ; 5 June 1883 – 21 April 1946), was an English economist whose ideas fundamentally changed the theory and practice of macroeconomics and the economic policies of governments. Originally trained in ...
wrote: "Speculators may do no harm as bubbles on a steady stream of
enterprise Enterprise (or the archaic spelling Enterprize) may refer to: Business and economics Brands and enterprises * Enterprise GP Holdings, an energy holding company * Enterprise plc, a UK civil engineering and maintenance company * Enterprise ...
. But the situation is serious when enterprise becomes the bubble on a whirlpool of speculation. (1936:159)" Keynes himself enjoyed speculation to the fullest, running an early precursor of a
hedge fund A hedge fund is a pooled investment fund that trades in relatively liquid assets and is able to make extensive use of more complex trading, portfolio-construction, and risk management techniques in an attempt to improve performance, such as ...
. As the Bursar of the Cambridge University King's College, he managed two investment funds, one of which, called Chest Fund, invested not only in the then 'emerging' market US stocks, but to a smaller extent periodically included commodity futures and foreign currencies (see Chua and Woodward, 1983). His fund was profitable almost every year, averaging 13% per year, even during the
Great Depression The Great Depression (19291939) was an economic shock that impacted most countries across the world. It was a period of economic depression that became evident after a major fall in stock prices in the United States. The economic contagio ...
, thanks to very modern investment strategies, which included inter-market
diversification Diversification may refer to: Biology and agriculture * Genetic divergence, emergence of subpopulations that have accumulated independent genetic changes * Agricultural diversification involves the re-allocation of some of a farm's resources to n ...
(it invested in stocks, commodities and currencies) as well as shorting (selling borrowed stocks or futures to profit from falling prices), which Keynes advocated among the principles of successful investment in his 1933 report: "a balanced investment position... and if possible, opposed risks". It is controversial whether the presence of speculators increases or decreases short-term volatility in a market. Their provision of capital and information may help stabilize prices closer to their true values. On the other hand, crowd behavior and positive feedback loops in market participants may also increase volatility.


Government responses and regulation

The economic disadvantages of speculation have resulted in a number of attempts over the years to introduce regulations and restrictions to try to limit or reduce the impact of speculators. States often enact such
financial regulation Financial regulation is a form of regulation or supervision, which subjects financial institutions to certain requirements, restrictions and guidelines, aiming to maintain the stability and integrity of the financial system. This may be handle ...
in response to a crisis. Note for example the
Bubble Act 1720 The Bubble Act 1720 (also Royal Exchange and London Assurance Corporation Act 1719) was an Act of the Parliament of Great Britain passed on 11 June 1720 that incorporated the Royal Exchange and London Assurance Corporation, but more significant ...
, which the British government passed at the height of the South Sea Bubble to try to stop speculation in such schemes. It remained in place for over a hundred years until repealed in 1825. The Glass–Steagall Act passed in 1933 during the
Great Depression in the United States In the History of the United States, United States, the Great Depression began with the Wall Street Crash of 1929, Wall Street Crash of October 1929 and then spread worldwide. The nadir came in 1931–1933, and recovery came in 1940. The stock m ...
provides another example; most of the Glass-Steagall provisions were repealed during the 1980s and 1990s. The Onion Futures Act bans the trading of futures contracts on onions in the United States, after speculators successfully cornered the market in the mid-1950s; it remains in effect . The
Soviet Union The Soviet Union,. officially the Union of Soviet Socialist Republics. (USSR),. was a transcontinental country that spanned much of Eurasia from 1922 to 1991. A flagship communist state, it was nominally a federal union of fifteen nationa ...
regarded any form of private trade with the intent of gaining profit as speculation ( ru , спекуляция) and a criminal offense and punished speculators accordingly with fines, imprisonment, confiscation and/or corrective labor. Speculation was specifically defined in article 154 of the Penal Code of the USSR.


Food security

Some nations have moved to limit foreign ownership of cropland to ensure that food is available for local consumption, while others have leased food land abroad despite receiving aid from the World Food Programme. In 1935, the
Indian government The Government of India (ISO: ; often abbreviated as GoI), known as the Union Government or Central Government but often simply as the Centre, is the national government of the Republic of India, a federal democracy located in South Asia, ...
passed a law allowing the government partial restriction and direct control of
food production The food industry is a complex, global network of diverse businesses that supplies most of the food consumed by the world's population. The food industry today has become highly diversified, with manufacturing ranging from small, traditional, ...
(Defence of India Act, 1935). It included the ability to restrict or ban the trading in derivatives on food commodities. After achieving independence in 1947, India in the 1950s continued to struggle with feeding its population and the government increasingly restricted trading in food commodities. Just at the time the
Forward Markets Commission The Forward Markets Commission (FMC) is the regulatory body for the commodity market and futures market in India. It is a division of the Securities and Exchange Board of India, Ministry of Finance, Government of India. As of July 2014, it regul ...
was established in 1953, the government felt that derivative markets increased speculation, which led to increased food costs and price instabilities. In 1953 it finally prohibited options- and futures-trading altogether. The restrictions were not lifted until the 1980s.


Regulations

In the
United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country Continental United States, primarily located in North America. It consists of 50 U.S. state, states, a Washington, D.C., ...
, following passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the
Commodity Futures Trading Commission The Commodity Futures Trading Commission (CFTC) is an independent agency of the US government created in 1974 that regulates the U.S. derivatives markets, which includes futures, swaps, and certain kinds of options. The Commodity Exchange Act ...
(CFTC) has proposed regulations aimed at limiting speculation in futures markets by instituting position limits. The CFTC offers three basic elements for their regulatory framework: "the size (or levels) of the limits themselves; the exemptions from the limits (for example, hedged positions) and; the policy on aggregating accounts for purposes of applying the limits". The proposed position limits would apply to 28 physical commodities traded in various exchanges across the US. Another part of the Dodd-Frank Act established the Volcker Rule, which deals with speculative investments of banks that do not benefit their customers. Passed on 21 January 2010, it states that those investments played a key role in the financial crisis of 2007–2010.


Proposals

Proposals made in the past to try to limit speculation – but never enacted – included: * The Tobin tax is a tax intended to reduce short-term currency speculation, ostensibly to stabilize foreign exchange. * In May 2008, German
leader Leadership, both as a research area and as a practical skill, encompasses the ability of an individual, group or organization to "lead", influence or guide other individuals, teams, or entire organizations. The word "leadership" often gets v ...
s planned to propose a worldwide ban on oil trading by speculators, blaming the 2008 oil price rises on manipulation by
hedge fund A hedge fund is a pooled investment fund that trades in relatively liquid assets and is able to make extensive use of more complex trading, portfolio-construction, and risk management techniques in an attempt to improve performance, such as ...
s. * On 3 December 2009, Representative
Peter DeFazio Peter Anthony DeFazio (; born May 27, 1947) is an American politician serving as the U.S. representative for , serving since 1987. He is a member of the Democratic Party. The district includes Eugene, Springfield, Corvallis, Roseburg, Coos Ba ...
, who blamed "reckless speculation" for the 2008 financial crisis, proposed the introduction of a financial transaction tax, which would have specifically targeted speculators by taxing financial-market securities transactions.


Books

* Covel, Michael.
The Complete Turtle Trader
'.
HarperCollins HarperCollins Publishers LLC is one of the Big Five English-language publishing companies, alongside Penguin Random House, Simon & Schuster, Hachette, and Macmillan. The company is headquartered in New York City and is a subsidiary of News C ...
, 2007. * Douglas, Mark. ''The Disciplined Trader''. New York Institute of Finance, 1990. * Gunther, Max ''The Zurich Axioms'' Souvenir Press (1st print 1985) . * Fox, Justin. ''The Myth of the Rational Market''. HarperCollings, 2009. * Lefèvre, Edwin.
Reminiscences of a Stock Operator
' John Wiley & Sons Inc., 2005 (1st print 1923) * Neill, Humphrey B. ''The Art of Contrary Thinking'' Caxton Press 1954. * Niederhoffer, Victor ''Practical Speculation'' John Wiley & Sons Inc., 2005 * Sobel, Robert ''The Money Manias: The Eras of Great Speculation in America, 1770-1970'' Beard Books 1973 * Patterson, Scott
The Quants, How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed it
' Crown Business, 2010 * Schwartz, Martin "Buzzy".
Pit Bull: Lessons from Wall Street's Champion Trader
' HarperCollins, 2007 * Schwager, Jack D. ''Trading with the Market Wizards: The Complete Market Wizards Series'' John Wiley & Sons 2013 * Tharp, Van K. ''Definitive Guide to Position Sizing'' International Institute of Trading Mastery, 2008.


See also

*
Adventurer An adventure is an exciting experience or undertaking that is typically bold, sometimes risky. Adventures may be activities with danger such as traveling, exploring, skydiving, mountain climbing, scuba diving, river rafting, or other extreme ...
* Behavioral finance * Black Wednesday *
Bull (stock market speculator) In finance, a bull is a speculator in a stock market who buys a holding in a stock in the expectation that, in the very short-term, it will rise in value, whereupon they will sell the stock to make a quick profit on the transaction. Strictly ...
*
Carbon credits A carbon credit is a generic term for any tradable certificate or permit representing the right to emit a set amount of carbon dioxide or the equivalent amount of a different greenhouse gas (tCO2e). Carbon credits and carbon markets are a compo ...
* Currency crisis * Currency transaction tax *
Day trading Day trading is a form of speculation in securities in which a trader buys and sells a financial instrument within the same trading day, so that all positions are closed before the market closes for the trading day to avoid unmanageable risks ...
* DeFazio financial transaction tax * Domain name speculation *
Equity (finance) In finance, equity is ownership of assets that may have debts or other liabilities attached to them. Equity is measured for accounting purposes by subtracting liabilities from the value of the assets. For example, if someone owns a car worth $ ...
* European crime * Fictitious capital *
Financial market A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities include stocks and bonds, raw materials and precious metals, which are known in the financial ma ...
* Financial regulatory reform * Flipping * Food speculation * George Soros *
Jesse Lauriston Livermore Jesse Lauriston Livermore (July 26, 1877 – November 28, 1940) was an American stock trader. He is considered a pioneer of day trading and was the basis for the main character of ''Reminiscences of a Stock Operator'', a best-selling book by Edw ...
*
Seasonal traders Seasonal spread traders are spread traders that take advantage of seasonal patterns by holding Long (finance), long and Short (finance), short positions in futures contracts simultaneously in the same or a related commodity markets, such as the Chi ...
* Short selling *
Slippage (finance) With regard to futures contracts as well as other financial instruments, slippage is the difference between where the computer signaled the entry and exit for a trade and where actual clients, with actual money, entered and exited the market usin ...
* Spahn tax * Speculative attack *
Stock market bubble A stock market bubble is a type of economic bubble taking place in stock markets when market participants drive stock prices above their value in relation to some system of stock valuation. Behavioral finance theory attributes stock market bu ...
* Stock trader * Tobin tax * Tulip mania * Volcker Rule


References


Further reading

* * *


External links


Hidden Collective Factors in Speculative Trading

Food Commodities Speculation and Food Price Crises

Understanding Derivatives: Markets and Infrastructure
Federal Reserve Bank of Chicago, Financial Markets Group {{Authority control Financial markets Money managers