.jpg)
| Financial market participants |
|---|
 |
| Organisations |
| Terms |
Infinance,speculation is the purchase of an asset (acommodity,goods, orreal estate) with the hope that it will become more valuable shortly. It can also refer toshort sales in which the speculator hopes for a decline in value.
Many speculators pay little attention to thefundamental value of a security and instead focus purely on price movements.[1][citation needed] In principle, speculation can involve any tradable good orfinancial instrument. Speculators are particularly common in the markets forstocks,bonds,commodity futures,currencies,cryptocurrency,fine art,collectibles,real estate, andfinancial derivatives.
Speculators play one of four primary roles in financial markets, along withhedgers, who engage in transactions to offset some other pre-existing risk,arbitrageurs who seek to profit from situations wherefungible instruments trade at different prices in different market segments, andinvestors who seek profit through long-term ownership of an instrument's underlying attributes.
With the appearance of thestock 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, from4.4 million in 1900 to26 million in 1932.[2]
The view of what distinguishesinvestment 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.[3] TheU.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".[4] The agency emphasizes that speculators serve important market functions, but defines excessive speculation as harmful to the proper functioning of futures markets.[5]
According toBenjamin Graham inThe Intelligent Investor, 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.[6]
Nicholas Kaldor[7] 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 speculatorVictor Niederhoffer, in "The Speculator as Hero",[8] 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 owncapital in the hope of profit, they addliquidity to the market and make it easier or even possible for others to offsetrisk, including those who may be classified ashedgers and arbitrageurs.
If any market, such aspork bellies, had no speculators, only producers (hog farmers) and consumers (butchers, etc.) would participate. With fewer players in the market, there would be a largerspread 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 thisilliquid market and might trade at market prices with largebid–ask spreads or even face difficulty finding a co-party to buy or sell to.
By contrast, acommodity 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 anefficient market.[9] 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 isprice 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.[9]
Speculators perform a risk-bearing role that can be beneficial to society. For example, a farmer might consider planting corn on unusedfarmland. 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).
Speculativehedge funds 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.[10]
Shorting may act as a "canary in a coal mine" to stop unsustainable practices earlier and thus reduce damages and form market bubbles.[10]
Auctions are a method of squeezing out speculators from a transaction, but they may have their ownperverse effects by thewinner'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.
Speculation is often associated witheconomic bubbles.[11] A bubble occurs when the price for an asset exceeds its intrinsic value by a significant margin,[12] although not all bubbles occur due to speculation.[13] Speculative bubbles are characterized by rapid market expansion driven by word-of-mouthfeedback loops, as initial rises in asset price attract new buyers and generate further inflation.[14] The growth of the bubble is followed by a precipitous collapse fueled by the same phenomenon.[12][15] Speculative bubbles are essentially social epidemics whose contagion is mediated by the structure of the market.[15] Some economists link asset price movements within a bubble to fundamental economic factors such as cash flows and discount rates.[16]
In 1936,John Maynard Keynes wrote: "Speculators may do no harm as bubbles on a steady stream ofenterprise. But the situation is serious when enterprise becomes the bubble on a whirlpool of speculation. (1936:159)"[17] Keynes himself enjoyed speculation to the fullest, running an early precursor of ahedge fund. 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 theGreat Depression, thanks to very modern investment strategies, which included inter-marketdiversification (it invested in stocks, commodities and currencies) as well asshorting (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".[18]
It is controversial whether the presence of speculators increases or decreases short-termvolatility 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.
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 suchfinancial regulation in response to a crisis. Note for example theBubble Act 1720, which the British government passed at the height of theSouth Sea Bubble to try to stop speculation in such schemes. It remained in place for over a hundred years until repealed in 1825. TheGlass–Steagall Act passed in 1933 during theGreat Depression in the United States provides another example; most of the Glass-Steagall provisions were repealed during the 1980s and 1990s. TheOnion Futures Act bans the trading offutures contracts on onions in the United States, after speculators successfully cornered the market in the mid-1950s; it remains in effect as of 2021[update].
TheSoviet Union regarded any form of private trade with the intent of gaining profit as speculation (Russian:спекуляция) and a criminal offense and punished speculators accordingly with fines, imprisonment, confiscation and/orcorrective labor. Speculation was specifically defined in article 154 of the Penal Code of the USSR.[19]
In theUnited States, following passage of theDodd-Frank Wall Street Reform and Consumer Protection Act of 2010, theCommodity Futures Trading Commission (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".[20] The proposed position limits would apply to 28 physical commodities traded in various exchanges across the US.[21]
Another part of the Dodd-Frank Act established theVolcker 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 the2007–2008 financial crisis.[22]
Proposals made in the past to try to limit speculation – but never enacted – included:
