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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 commodit ...
,
good 175px, In many religions, angels are considered to be good beings. 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 ...
s, 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 general ...
) with the hope that it will become more valuable in the near future. In finance, speculation is also the practice of engaging in risky financial transactions in an attempt to profit from ''short term fluctuations'' in the
market value Market may refer to: *Market (economics) *Market economy *Marketplace, a physical marketplace or public market Geography *Märket, an island shared by Finland and Sweden Art, entertainment, and media Films *''Market'' (1965 film), 1965 South K ...
of a tradable
financial instrument Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money available which could ...
—rather than attempting to profit from the underlying financial attributes embodied in the instrument such as value addition, return on investment, or dividends. Many speculators pay little attention to the
fundamental value In finance, intrinsic value of an asset usually refers to a value calculated on simplified assumptions. For example the intrinsic value of an option is based on the current market value of the underlying instrument, ignoring the possibility of futu ...
of a security and instead focus purely on price movements. Speculation can in principle involve any tradable good or financial instrument. Speculators are particularly common in the markets for
stock Stock (also capital stock) is all of the shares into which ownership of a corporation is divided.Longman Business English Dictionary In American English, the shares are collectively known as "stock". A single share of the stock represents fra ...

stock
s,
bonds Bond or bonds may refer to: Common meanings * Bond (finance), a type of debt security * Bail bond, a commercial third-party guarantor of surety bonds in the United States * Chemical bond, the attraction of atoms, ions or molecules to form chemical ...
,
commodity futures In finance, a futures contract (sometimes called futures) is a standardized legal agreement to buy or sell something at a predetermined price at a specified time in the future, between parties not known to each other. The asset transacted is usuall ...
,
currencies A currency, "in circulation", from la, currens, -entis, literally meaning "running" or "traversing" in the most specific sense is money in any form when in use or circulation as a medium of exchange, especially circulating banknotes and coins. ...
,
fine art 250px, ''The Art of Painting''; by Johannes Vermeer; 1666–1668; oil on canvas; 1.3 × 1.1 m; Kunsthistorisches Museum (Vienna, Austria) In European academic traditions, fine art is art developed primarily for aesthetics or beauty, ...
,
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 to ...
s,
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 general ...
, and
derivatives Derivative may refer to: In mathematics and economics *Brzozowski derivative in the theory of formal languages *Derivative in calculus, a quantity indicating how a function changes when the values of its inputs change. *Formal derivative, an opera ...
. 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 price difference between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between ...
urs who seek to profit from situations where
fungible In economics, fungibility is the property of a good or a commodity whose individual units are essentially interchangeable, and each of its parts is indistinguishable from another part. For example, gold is fungible since a specified amount of p ...
instruments trade at different prices in different market segments, and
investor An investor is a person that allocates capital with the expectation of a future financial return (profit) or to gain an advantage (interest). Through this allocated capital most of the time the investor purchases some species of property. Types ...
s 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 a s ...
in 1867, which removed the need for traders to be physically present on the floor of a stock exchange, 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. According to Benjamin Graham in ''
The Intelligent Investor ''The Intelligent Investor'' by Benjamin Graham, first published in 1949, is a widely acclaimed book on value investing. The book teaches readers strategies on how to successfully use value investing in the stock market. Historically, the book has ...
'', 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

Speculation usually involves more risks than investment. Nicholas Kaldor 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 Victor Niederhoffer (born December 10, 1943) is an American hedge fund manager, champion squash player, bestselling author and statistician. Life and career Niederhoffer was born in Brooklyn to a Jewish family. His paternal grandfather Martin (Ma ...
, 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 most commonly refers to: * Capital letter, an upper-case letter in any type of writing * Capital city, the area of a country, province, region, or state, regarded as enjoying primary status, usually but not always the seat of the governm ...
in the hope of profit, they add
liquidityLiquidity is a concept in economics involving the convertibility of assets and obligations. It can include: * Market liquidity, the ease with which an asset can be sold * Accounting liquidity, the ability to meet cash obligations when due * Liquid c ...
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 environmen ...
, including those who may be classified as hedgers and arbitrageurs.


Market liquidity and efficiency

If any market, such as
pork bellies Pork belly is a boneless cut of fatty meat from the belly of a pig. Pork belly is particularly popular in Hispanic, Chinese, Danish, Norwegian, Korean, Thai and Filipino cuisine. Regional variations Alsace In Alsatian cuisine, pork belly is pr ...
, 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 ask 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 limit order book) for an immediate sale (offer) and an immediate purc ...
s 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 commodit ...
speculator may profit 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 ...
.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 The price discovery process (also called price discovery mechanism) is the process of determining the price of an asset in the marketplace through the interactions of buyers and sellers. The futures and options market serve important functions of p ...
. 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 be considering planting corn on some 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 both f ...
. 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 is now able to hedge the price risk and so he can plant the corn. Thus, speculators can actually 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 short ...
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 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 ass ...

Shorting
may act as a "canary in a coal mine" to stop unsustainable practices earlier and thus reduce damages and forming 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 a phenomenon that may occur in common value auctions, where all bidders have the same (''ex post'') value for an item but receive different private (''ex ante'') signals about this value and wherein the winner is the bidder w ...

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 or asset bubble (sometimes also referred to as a speculative bubble, a market bubble, a price bubble, a financial bubble, a speculative mania, or a balloon) is a situation in which asset prices appear to be based on implausible ...
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 handled ca ...

feedback loop
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, whose ideas fundamentally changed the theory and practice of macroeconomics and the economic policies of governments. Originally trained in ma ...

John Maynard Keynes
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
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 short ...
. 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 worldwide economic depression that took place mostly during the 1930s, beginning in the United States. The timing of the Great Depression varied across the world; in most countries, it started in 1929 and las ...
, thanks to very modern investment strategies, which included inter-market diversification (it invested in stocks, commodities and currencies) as well as
shorting 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 ass ...
(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 handled b ...
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. South is the opposite of north and is perpendicular to the east and west. Etymology The word ''south'' comes from Old English ''sūþ'', from earlier Proto-Germanic ''*sunþaz'' ("south" ...

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 Dorothea Lange's 1936 photo ''Migrant Mother'' is one of the most iconic photos associated with the Great Depression The Great Depression began with the Wall Street Crash of 1929, Wall Street Crash in October 1929. The stock market crash 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 In finance, a futures contract (sometimes called futures) is a standardized legal agreement to buy or sell something at a predetermined price at a specified time in the future, between parties not known to each other. The asset transacted is usuall ...
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 federal socialist state in Northern Eurasia that existed from 1922 to 1991. Nominally a union of multiple national Soviet republics, in practice its governmen ...
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 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 both f ...
to ensure that food is available for local consumption, while others have leased food land abroad despite receiving aid from the
World Food Programme The World Food Programme; it, Programma alimentare mondiale; es, Programa Mundial de Alimentos; ar, برنامج الأغذية العالمي, translit=barnamaj al'aghdhiat alealami; russian: Всемирная продовольственная ...
. In 1935, the
Indian government#REDIRECT Government of India#REDIRECT Government of India#REDIRECT Government of India {{R from other capitalisation ... {{R from other capitalisation ...
{{R from other capitalisation ...
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 term food industries covers a series of industrial activities directed at the production, distribution, ...
(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 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 of America The United States of America (USA), commonly known as the United States (U.S. or US), or America, is a country primarily located in North America. It consists of 50 states, a federal district, five major self-governing territories, 326 India ...
, 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 (C ...
(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 refers tof 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 to restrict United States banks f ...
, 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 Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money available which could ...
.


Proposals

Proposals made in the past to try to limit speculation – but never enacted – included: * The
Tobin tax A Tobin tax was originally defined as a tax on all spot conversions of one currency into another. It was suggested by James Tobin, an economist who won the Nobel Memorial Prize in Economic Sciences. Tobin's tax was originally intended to penalize ...
is a tax intended to reduce short-term currency speculation, ostensibly to stabilize foreign exchange. * In May 2008, German
leader Leadership is both a research area, and a practical skill encompassing the ability of an individual, group or organization to "lead", influence or guide other individuals, teams, or entire organizations. Often viewed as a contested term, speciali ...
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 short ...
s. * On 3 December 2009, Representative
Peter DeFazio Peter Anthony DeFazio (; born May 27, 1947) is the U.S. Representative for , serving since 1987. He is a member of the Democratic Party. The district includes Eugene, Springfield, Corvallis, Roseburg, Coos Bay and Florence. He chairs the House Tra ...
, who blamed "reckless speculation" for the 2008 financial crisis, proposed the introduction of a
financial transaction tax A financial transaction tax is a levy on a specific type of financial transaction for a particular purpose. The concept has been most commonly associated with the financial sector; it is not usually considered to include consumption taxes paid by ...
, 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 world's largest publishing companies and is one of the Big Five English-language publishing companies, alongside Penguin Random House, Simon & Schuster, Hachette, and Macmillan. The company is headquarter ...
, 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 that is typically bold, sometimes risky or undertaking. Adventures may be activities with some potential for physical danger such as traveling, exploring, skydiving, mountain climbing, scuba diving, river ra ...
*
Behavioral finance Behavioral economics (also, behavioural economics) studies the effects of psychological, cognitive, emotional, cultural and social factors on the decisions of individuals and institutions and how those decisions vary from those implied by clas ...
*
Black Wednesday Black Wednesday occurred on 16 September 1992 when the British government was forced to withdraw the pound sterling from the European Exchange Rate Mechanism (ERM), after a failed attempt to keep the pound above the lower currency exchange lim ...
*
Bull (stock market speculator) A bull is a stock market speculator 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 speaking the term applies t ...
* Carbon credits * Currency crisis * Currency transaction tax * Day trading * DeFazio financial transaction tax * Domain name speculation * Equity (finance) * European crime * Fictitious capital * Financial market * Financial regulatory reform * Flipping * Food speculation * George Soros * Jesse Lauriston Livermore * Seasonal traders * Short selling * Slippage (finance) * Spahn tax * Speculative attack * Stock market bubble * Stock trader *
Tobin tax A Tobin tax was originally defined as a tax on all spot conversions of one currency into another. It was suggested by James Tobin, an economist who won the Nobel Memorial Prize in Economic Sciences. Tobin's tax was originally intended to penalize ...
* Tulip mania *
Volcker Rule The Volcker Rule refers tof 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 to restrict United States banks f ...


References

;Bibliography * *


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