Speculation

From Wikipedia, the free encyclopedia.

Speculation involves the buying, holding, and selling of stocks, bonds, commodities, currencies, collectibles, real estate, derivatives or any valuable thing to profit from fluctuations in its price as opposed to buying it for use or for income ( via dividends, interest etc). Speculation or agiotage represents one of three market roles in western financial markets, distinct from hedging and arbitrage.

1 Speculation areas
2 Type of speculators
3 The economic role of speculation
4 Some perverse effects
5 See also
6 External links

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Speculation areas

Convention - and especially satire - sometimes depicts speculators comically as speculating in pork bellies (in which a real market and real speculators exist) and often "losing their shirts" or making a fortune upon small market changes. Speculation exists in many such commodities but, if measured by value, the most important markets deal in financial futures contracts and other derivatives which involve leverage that can transform a small market movement into a huge gain or loss.

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Type of speculators

Most non-professional traders lose money on speculation, while those that do make money tend to become professional. Occasionally some dramatic event will occur such as the effort of the Hunt brothers to corner the silver market or the currency speculations of George Soros.

Many "investors" in the stock market actually speculate, betting on a gain in price: "buy low sell high".

In fact, it is hard to differentiate a speculator from an investor. The degree of leverage, the length of holding, and the frequency of operations might offer clues for distinguishing the two roles. But a degree of speculation exists in every investing decision, and even in every life action that ventures to anticipate the future. Speculation (gambling) appears as a very common human trait.

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The economic role of speculation

The roles of speculators in a market economy are to absorb risk and to add liquidity to the marketplace by risking their own capital for the chance of monetary reward.

For example, if a certain market - say in pork bellies - had no speculators, only producers (pig farmers) and consumers (butchers etc) would participate in that market. With fewer players in the market, there would be a larger spread between the current bid and ask price of pork bellies. Any new entrant in the market who wants to either buy or sell pork bellies will be forced to accept an illiquid market and market prices that have a large bid-ask spread. A speculator (e.g. a pork dealer) will exploit the difference in the spread and, in competition with other speculators, reduce the spread thus creating a more efficient market.

Another example of the value of speculators is the ability of a pig farmer to sell his pork on a futures exchange at a known price ahead of its production.

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Some perverse effects

Auctions are a method of squeezing out speculators from a transaction, but they have their own perverse effects; see winner's curse.

Speculative purchasing can also create inflationary pressure, causing particular prices to increase above their "true value" (real value - adjusted for inflation) simply because the speculative purchasing artificially increases the demand. Speculative selling can also have the opposite effect, causing prices to artificially decrease below their "true value" in a similar fashion. In various situations price rises due to speculative purchasing cause further speculative purchasing in the hope that the price will continue to rise. This creates a positive feedback loop in which prices rise dramatically above the underlying "value" or "worth" of the items. This is known as an economic bubble. Such a period of increasing speculative purchasing is typically followed by one of speculative selling in which the price falls significantly, akin to a crash (see stock market crash). This crash is often greater in severity than the preceeding period of rising prices.

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