finance Finance refers to monetary resources and to the study and Academic discipline, discipline of money, currency, assets and Liability (financial accounting), liabilities. As a subject of study, is a field of Business administration, Business Admin ...

, speculation is the purchase of an asset (a

commodity In economics, a commodity is an economic goods, good, usually a resource, that specifically has full or substantial fungibility: that is, the Market (economics), market treats instances of the good as equivalent or nearly so with no regard to w ...

good In most contexts, the concept of good denotes the conduct that should be preferred when posed with a choice between possible actions. Good is generally considered to be the opposite of evil. The specific meaning and etymology of the term and its ...

s, or real estate) with the hope that it will become more valuable in a brief amount of time. It can also refer to short sales 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

stock Stocks (also capital stock, or sometimes interchangeably, shares) consist of all the Share (finance), shares by which ownership of a corporation or company is divided. A single share of the stock means fractional ownership of the corporatio ...

s, bonds,

commodity futures In finance, a futures contract (sometimes called futures) is a standardized legal contract to buy or sell something at a predetermined price for delivery at a specified time in the future, between parties not yet known to each other. The item tr ...

, currencies,

cryptocurrency A cryptocurrency (colloquially crypto) is a digital currency designed to work through a computer network that is not reliant on any central authority, such as a government or bank, to uphold or maintain it. Individual coin ownership record ...

fine art In European academic traditions, fine art (or, fine arts) is made primarily for aesthetics or creative expression, distinguishing it from popular art, decorative art or applied art, which also either serve some practical function (such as ...

collectible A collectable (collectible or collector's item) is any object regarded as being of value or interest to a collector. Collectable items are not necessarily monetarily valuable or uncommon. There are numerous types of collectables and terms t ...

s, real estate, and

financial derivatives In finance, a derivative is a contract between a buyer and a seller. The derivative can take various forms, depending on the transaction, but every derivative has the following four elements: # an item (the "underlier") that can or must be bou ...

. 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 Arbitrage (, ) is the practice of taking advantage of a difference in prices in two or more marketsstriking a combination of matching deals to capitalize on the difference, the profit being the difference between the market prices at which th ...

urs who seek to profit from situations where

fungible In economics and law, fungibility is the property of something whose individual units are considered fundamentally interchangeable with each other. For example, the fungibility of money means that a $100 bill (note) is considered entirely equ ...

instruments trade at different prices in different market segments, and

investor An investor is a person who allocates financial capital with the expectation of a future Return on capital, return (profit) or to gain an advantage (interest). Through this allocated capital the investor usually purchases some species of pr ...

s who seek profit through long-term ownership of an instrument's underlying attributes.

History

With the appearance of the stock ticker machine 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..

Speculation vs. investment

The view of what distinguishes

investment Investment is traditionally defined as the "commitment of resources into something expected to gain value over time". If an investment involves money, then it can be defined as a "commitment of money to receive more money later". From a broade ...

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. According to

Benjamin Graham Benjamin Graham (; Given name, né Grossbaum; May 9, 1894 – September 21, 1976) was a British-born American financial analyst, economist, accountant, investor and professor. He is widely known as the "father of value investing", and wrote two ...

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 ...

'', the prototypical defensive investor is "one interested chiefly in safety plus freedom from bother". He adds 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 Hungarian-born British economist. He developed the "compensation" criteria called Kaldor–Hicks efficiency for welfare spending, welfare comparisons ...

has long argued for 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 Victor Niederhoffer (born December 10, 1943) is an American hedge fund manager, champion Squash (sport), squash player, bestselling author and statistics, statistician. Life and career Niederhoffer was born in Brooklyn to a Jewish family. His p ...

, 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 in the hope of profit, they add

liquidity Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include: * Market liquidity In business, economics or investment, market liquidity is a market's feature whereby an individual or firm can quic ...

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 environ ...

, 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 spread The bid–ask spread (also bid–offer or bid/ask and buy/sell in the case of a market maker) is the difference between the prices quoted (either by a single market maker or in a Order book (trading), limit order book) for an immediate sale (Ask ...

s or even face difficulty finding a co-party to buy or sell to. By contrast, a

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 The efficient-market hypothesis (EMH) is a hypothesis in financial economics that states that asset prices reflect all available information. A direct implication is that it is impossible to "beat the market" consistently on a risk-adjusted basis ...

. 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 bot ...

. 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 Pooling (resource management), pooled investment fund that holds Market liquidity, liquid assets and that makes use of complex trader (finance), trading and risk management techniques to aim to improve investment performance and ...

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 economy is an area of the Production (economics), production, Distribution (economics), distribution and trade, as well as Consumption (economics), consumption of Goods (economics), goods and Service (economics), services. In general, it is ...

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 loop Feedback occurs when outputs of a system are routed back as inputs as part of a chain of cause and effect that forms a circuit or loop. The system can then be said to ''feed back'' into itself. The notion of cause-and-effect has to be handle ...

s, 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 and philosopher whose ideas fundamentally changed the theory and practice of macroeconomics and the economic policies of governments. Originall ...

wrote: "Speculators may do no harm as bubbles on a steady stream of 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

. 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 was a severe global economic downturn from 1929 to 1939. The period was characterized by high rates of unemployment and poverty, drastic reductions in industrial production and international trade, and widespread bank and ...

, thanks to very modern investment strategies, which included inter-market diversification (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 broad set of policies that apply to the financial sector in most jurisdictions, justified by two main features of finance: systemic risk, which implies that the failure of financial firms involves public interest consi ...

in response to a crisis. Note for example the Bubble Act 1720, which the British government passed at the height of the

South Sea Bubble South is one of the cardinal directions or compass points. The direction is the opposite of north and is perpendicular to both west and east. Etymology The word ''south'' comes from Old English ''sūþ'', from earlier Proto-Germanic ''*sunþa ...

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 United States, the Great Depression began with the Wall Street Crash of October 1929 and then spread worldwide. The nadir came in 1931–1933, and recovery came in 1940. The stock market crash marked the beginning of a decade of high u ...

provides another example; most of the Glass-Steagall provisions were repealed during the 1980s and 1990s. The

Onion Futures Act The Onion Futures Act is a United States law banning the trading of futures contracts on onions as well as "motion picture box office receipts". In 1955, two onion traders, Sam Siegel and Vincent Kosuga, Cornering the market, cornered the onion ...

bans the trading of

futures contracts In finance, a futures contract (sometimes called futures) is a standardized legal contract to buy or sell something at a predetermined price for delivery at a specified time in the future, between parties not yet known to each other. The item tr ...

on onions in the United States, after speculators successfully cornered the market in the mid-1950s; it remains in effect . The

Soviet Union The Union of Soviet Socialist Republics. (USSR), commonly known as the Soviet Union, was a List of former transcontinental countries#Since 1700, transcontinental country that spanned much of Eurasia from 1922 until Dissolution of the Soviet ...

regarded any form of private trade with the intent of gaining profit as speculation () 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.

Regulations

In the

United States The United States of America (USA), also known as the United States (U.S.) or America, is a country primarily located in North America. It is a federal republic of 50 U.S. state, states and a federal capital district, Washington, D.C. The 48 ...

, 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 agencies of the United States government, independent agency of the US government created in 1974 that regulates the U.S. derivatives markets, which includes futures contract, fut ...

(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 The Volcker Rule is sectioof the Dodd–Frank Wall Street Reform and Consumer Protection Act (). The rule was originally proposed by American economist and former United States Federal Reserve Chairman Paul Volcker in 2010 to restrict United S ...

, 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

2008 financial crisis The 2008 financial crisis, also known as the global financial crisis (GFC), was a major worldwide financial crisis centered in the United States. The causes of the 2008 crisis included excessive speculation on housing values by both homeowners ...

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, is defined as the ability of an individual, group, or organization to "", influence, or guide other individuals, teams, or organizations. "Leadership" is a contested term. Specialist literature debates various viewpoints on the co ...

s planned to propose a worldwide ban on oil trading by speculators, blaming the 2008

oil price The price of oil, or the oil price, generally refers to the spot price of a Oil barrel, barrel () of benchmark crude oil—a reference price for buyers and sellers of crude oil such as West Texas Intermediate (WTI), Brent Crude, Dubai Crud ...

rises on manipulation by

s. * On 3 December 2009, Representative Peter DeFazio, who blamed "reckless speculation" for the

, proposed the introduction of a financial transaction tax, which would have specifically targeted speculators by taxing financial-market securities transactions.

References

Books

* Covel, Michael.
The Complete Turtle Trader
'.

HarperCollins HarperCollins Publishers LLC is a British–American publishing company that is considered to be one of the "Big Five (publishers), Big Five" English-language publishers, along with Penguin Random House, Hachette Book Group USA, Hachette, Macmi ...

, 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''. Harper Collins, 2009. * Harper, H. H.
The psychology of speculation: The human element in stock market transactions
', privately printed 1926 * ----
After the stock market crash of November, 1929
' The Torch Press, 1930 * 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.

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 Trade Financial markets Money managers