Speculation

Speculation can be described as the act of buying and selling securities specifically with the hope that one will benefit from price changes. Speculation is often considered a huge gamble because there is always a good chance that one might lose a big part of their initial investment in case the price fluctuations do not favor them.However, speculative trading should be looked at as a calculated risk rather than just another form of gambling. As opposed to gambling, speculation does not fully depend on chance.  There is usually an array of market indications that traders base on to make their judgment when speculating.

In some circumstances, it is difficult to differentiate between a speculative trader and an investor. Usually, an investor is supposed to hold on to the securities and earn income from them.  On the other hand, speculators may not even need those items at all, except for the fact they are hoping to sell them at a higher price and make some bigprofits.However, there are times when these two look very similar.For example, when you buy a house specifically because you want to rent out and benefit from the rent, that easily qualifies as an investment venture. Bu when you buy multiple condominiums with little capital, then that can easily pass for an act of speculation.

Generally, speculators are attracted to a given asset not because they need it, but because they think the prices might rise in the future. Therefore, in a typical stock market, the presence of speculators could force an asset’s price to rise above it’s considered worth. This is because the speculators tend to increase the demand for that asset, driving the prices higher. Speculative buying usually precedes speculative selling.  Usually, when people start selling out their stocks, speculators will also start selling out in a hurry with the expectation that the prices are going to fall further because of the increasing supply.

In a stock market, speculation does play an important role in the pricing as well as trading of stocks. Perhaps the most important role is that of increasing marketliquidity.Ordinarily, the market is driven by seemingly natural forces of demand and supply. Investors buy market assets according to their value.  This means that there are only two parties involved in trading- The buyer and the seller. In this case the market becomes quite rigid and disadvantageous for players because the cash flow is minimal. This is where speculators come in. By buying securities that they don’t actually need, speculators increase the demand for the asset, leading to increase in prices. Likewise, speculative selling and short-selling also increases the supply, leading to further lowering of prices. Speculators short-sell when prices start to fall and are expected to fall further. When they short sell, they expect to buy back their assets later at a lower price.

Generally speaking, speculation is good for the market because it reduces the bid-ask gap, which makes the markets more stable and more profitable, even for investors.

via:http://www.whatiseconomics.org/speculation?utm_source=rss&utm_medium=rss&utm_campaign=speculation