Financial speculation, involves the buying, holding, selling, and short-selling of stocks, bonds, commodities, currencies, collectibles, real estate, derivatives, or any valuable financial instrument to profit from fluctuations in its price as opposed to buying it for use or for income via methods such as dividends or interest. There are two basic financial market participant categories Investor vs See Investor AB for the Swedish investment company An investor is any party that makes an Investment. A hedge fund is a private Investment fund open to a limited range of investors which is permitted by regulators to undertake a wider range of activities than other investment In Finance, private equity is an Asset class consisting of equity Securities in operating companies that are not Publicly traded on Venture capital (also known as VC or Venture) is a type of Private equity capital typically provided to immature high-potential growth companies Institutional investors are organizations which pool large sums of money and invest those sums in companies A banker or bank is a Financial institution whose primary activity is to act as a payment agent for customers and to borrow and lend money A building society is a financial institution owned by its members, that offers banking and other Financial services, especially mortgage lending A trust company is a Corporation, especially a Commercial bank, organized to perform the Fiduciary functions of trusts and agencies A collective investment scheme is a way of investing money with other people to participate in a wider range of investments than those feasible for most individual investors A credit union is a Cooperative Financial institution that is owned and controlled by its members and operated for the purpose of promoting thrift providing credit Insurance, in Law and Economics, is a form of Risk management primarily used to hedge against the Risk of a contingent loss Investment banks profit from companies and governments by raising money through issuing and selling Securities in the Capital markets (both equity and A pension fund is a pool of assets forming an independent legal entity that are bought with the contributions to a Pension plan for the exclusive purpose of financing pension Prime brokerage is the generic name for a bundled package of services offered by Investment banks and securities firms to Hedge funds and other professional investors A trust company is a Corporation, especially a Commercial bank, organized to perform the Fiduciary functions of trusts and agencies The field of finance refers to the concepts of Time, Money and Risk and how they are interrelated In Economics, a financial market is a mechanism that allows people to easily buy and sell ( Trade) financial Securities (such as stocks and bonds There are two basic financial market participant categories Investor vs Corporate finance is an area of Finance dealing with the financial decisions Corporations make and the tools and analysis used to make these decisions Personal finance is the application of the principles of Finance to the monetary decisions of an individual or family unit Public finance is a field of economics concerned with paying for collective or governmental activities and with the administration and design of those activities A banker or bank is a Financial institution whose primary activity is to act as a payment agent for customers and to borrow and lend money Financial regulations are a form of Regulation or supervision which subjects Financial institutions to certain requirements restrictions and guidelines aiming to Trade is the willing exchange of goods, services, or both Trade is also called Commerce. Software for Fixed assets management and Stock control developed in 2004. In Finance, a bond is a Debt security, in which the authorized issuer owes the holders a debt and is obliged to repay the principal and Interest A commodity is anything for which there is demand but which is supplied without qualitative differentiation across a market A currency is a unit of exchange, facilitating the transfer of Goods and/or services It is one form of Money, where money is For the record label see Collectables Records For the Ashanti album see Collectables by Ashanti A collectable Real estate is a legal term (in some jurisdictions notably in the USA, United Kingdom Derivatives are Financial instruments whose values depend on the value of other underlying financial instruments Financial instruments are cash evidence of an ownership interest in an entity or a contractual right to receive or deliver cash or another financial instrument Dividends are payments made by a Corporation to its Shareholder members Interest is a fee paid on borrowed capital Assets lent include Money, Shares, Consumer goods through Hire purchase, major assets Speculation or agiotage represents one of four market roles in Western financial markets, distinct from hedging, long- or short-term investing, and arbitrage. Sao Paulo Stock Exchangejpg|thumb| Virtual market arena where buyer and seller are not present and trade via intemediates and electronical information In Economics, a financial market is a mechanism that allows people to easily buy and sell ( Trade) financial Securities (such as stocks and bonds In Finance, a hedge is an investment that is taken out specifically to reduce or cancel out the Risk in another investment Investment or investing is a term with several closely-related meanings in Business management, Finance and Economics, related to saving In Economics and Finance, arbitrage is the practice of taking advantage of a price differential between two or more Markets striking a combination of matching
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Speculation areas
Convention, and especially satire, sometimes portray 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 on small market changes. The pork belly is the underside of the pig from which Bacon is made in the United States (in other parts of the world bacon is more often made from back and side meats and Speculation exists in many such commodities, but, if measured by value, the most important markets deal in futures contracts and other derivatives involving leverage that can transform a small market movement into a huge gain or loss. In Finance, a futures contract is a standardized Contract, traded on a Futures exchange, to buy or sell a certain Underlying instrument Derivatives are Financial instruments whose values depend on the value of other underlying financial instruments In Finance, leverage (or gearing) is using given resources in such a way that the potential positive or negative outcome is magnified and/or enhanced
Type of speculators
Most non-professional traders lose money on speculation, while those who do make money tend to become professionals. The term profession is applied to those persons who have specialized and technical skill or knowledge which they apply for a fee to certain tasks that ordinary and unqualified people cannot 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 or the speculative trading of Nick Leeson, which caused the collapse of Barings Bank. Nelson Bunker Hunt (born February 22, 1926) is an American oil company executive Silver (ˈsɪlvɚ is a Chemical element with the symbol " Ag " (argentum from the Ancient Greek: ἀργήντος - argēntos gen George Soros (ˈsɔroʊs or /ˈsɔrəs/ Hungarian ˈʃoroʃ (born August 12, 1930, in Budapest, Hungary, as György Schwartz) is Nicholas Leeson (born February 25, 1967) is a former derivatives trader whose unsupervised speculative trading caused the collapse of Barings Barings Bank (1762 to 1995 was the oldest Merchant bank in London until its collapse in 1995 after one of the bank's employees Nick Leeson, lost £827
By some definitions, most long-term investors, even those who buy and hold for decades, may be classified as speculators, excepting only the rare few who are not primarily motivated by eventually selling at a good profit. Some dedicated speculators are distinguished by shorter holding times, the use of leverage, by being willing to take short positions as well as long positions (in markets where the distinction can be reasonably made). In Finance, leverage (or gearing) is using given resources in such a way that the potential positive or negative outcome is magnified and/or enhanced In Finance, short selling or "shorting" is the practice of selling a Financial instrument that the seller borrows first (does not own and then In finance a long position in a security such as a Stock or a bond, or equivalently to be long in a security means the holder of the position owns the A degree of speculation exists in a wide range of financial decisions, from the purchase of a house to a bet on a horse; this is what modern market economists call "ubiquitous speculation. "
In Security Analysis, Benjamin Graham gave a definition of speculation in relation to investment: "An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Benjamin Graham ( May 8, 1894 &ndash September 21, 1976) was an influential Economist and professional investor. Financial analysis refers to an assessment of the viability stability and profitability of a Business, sub-business or Project. Returns, in economics and political economy are the distributions or payments awarded to the various suppliers of the Factors of production. Operations not meeting these requirements are speculative. "
The economic benefits of speculation
The well known speculator Victor Niederhoffer, in "The Speculator as Hero"[1] 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. Victor Niederhoffer (born 1943 is a Hedge fund manager champion squash player and statistician. 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 to the market and make it easier for others to offset risk, including those who may be classified as hedgers and arbitrageurs. In Economics, capital or capital Goods or real capital refers to items of extensive value Market liquidity is a Business, Economics or Investment term that refers to an Asset 's ability to be easily converted through an act of buying Risk is a Concept that denotes the precise probability of specific eventualities In Finance, a hedge is an investment that is taken out specifically to reduce or cancel out the Risk in another investment
If a certain market - for example, pork bellies - had no speculators, then only producers (hog 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. The bid/offer spread (also known as bid/ask spread) for assets (such as Stock, Futures contracts options, or Currency pairs is Any new entrant in the market who wants to either buy or sell pork bellies would be forced to accept an illiquid market and market prices that have a large bid-ask spread or might even find it difficult to find a co-party to buy or sell to. Market liquidity is a Business, Economics or Investment term that refers to an Asset 's ability to be easily converted through an act of buying A speculator (e. g. a pork dealer) may exploit the difference in the spread and, in competition with other speculators, reduce the spread, thus creating a more efficient market.
Some side effects
Auctions are a method of squeezing out speculators from a transaction, but they may have their own perverse effects; see winner's curse. Unintended consequences are outcomes that are not (or not limited to what the actor intended in a particular situation The winner's curse is a phenomenon akin to a Pyrrhic victory that occurs in common value Auctions with Incomplete information. 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. This mechanism prevents the winner's curse phenomenon from causing mispricing to any degree greater than the spread.
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. Positive feedback, sometimes referred to as "cumulative causation" is a Feedback loop system in which the system responds to perturbation in the same direction This is known as an economic bubble. An economic bubble (sometimes referred to as a speculative bubble, a market bubble, a price bubble, a financial bubble, or a speculative Such a period of increasing speculative purchasing is typically followed by one of speculative selling in which the price falls significantly, in extreme cases this may lead to crashes. A stock market crash is a sudden dramatic decline of Stock prices across a significant cross-section of a Stock market. Overall, the participation of speculators in financial markets tends to be accompanied by significant increase in short-term market volatility. This is not necessarily a bad thing, as heightened level of volatility implies that the market will be able to correct perceived mispricings more rapidly and in a more drastic manner.
Etymology
The Etymology of the word is as follows; from O. Fr. speculation, from L. L. speculationem (nom. speculatio) "contemplation, observation," from L. speculatus, pp. of speculari "observe," from specere "to look at, view". Speculator in the financial sense is first recorded 1778. Speculate is a 1599 back-formation.
What is significant to note is the change from a passive to an active form of use. Specifically from a strict observer to one who contemplates what they observe then further to one who contemplates and acts on what they observe.
With these changes, the word as now commonly used, describes one who observes an object, event, or situation and takes some form of action with regard to the observed, all the while aware they may not know all the facts or factors regarding or affecting that which they observe. E. g. the financial speculator, one who understands and accepts he may not know all the facts or risks involved with a venture, yet chooses to invest his capital in the venture for the possibility of receiving greater capital in return.
Problems caused by financial speculation
Financial speculation has been blamed as main cause of various economic crises around the world. [2][3]
Regulating Speculation
The Tobin tax is a tax design to reduce short-term currency speculation. A Tobin tax is the suggested Tax on all Trade of Currency across borders
In May 2008, German leaders have planned to propose a worldwide ban on oil trading by speculators, blaming the 2008 oil price rises on manipulation by hedge funds. A hedge fund is a private Investment fund open to a limited range of investors which is permitted by regulators to undertake a wider range of activities than other investment [4]
Books
- Sobel, Robert [1973] (2000). The Money Manias: The Eras of Great Speculation in America, 1770-1970. Beard Books. ISBN 1-58798-028-2.
- Gunther, Max (1992). The Zurich Axioms. Souvenir Press. ISBN 0-285-63095-4.
- Niederhoffer, Victor (2005). Practical Speculation. Wiley. ISBN 0-471-67774-4.
References
- ^ Victor Niederhoffer, The Wall Street Journal, February 10, 1989 Daily Speculations
- ^ America's enemy within - Inflation has slipped by Fed defences
- ^ "The trading frenzy that sent prices soaring", New Statesman. The New Statesman is a British Left-wing political Magazine published weekly in London. Retrieved on 2008-04-28. 2008 ( MMVIII) is the current year in accordance with the Gregorian calendar, a Leap year that started on Tuesday of the Common Events 1192 - Assassination of Conrad of Montferrat (Conrad I King of Jerusalem, in Tyre, two days after his title
- ^ "Germany in call for ban on oil speculation", The Daily Telegraph. For "The Daily Telegraph" in Australia see The Daily Telegraph (Australia. Retrieved on 2008-05-28. 2008 ( MMVIII) is the current year in accordance with the Gregorian calendar, a Leap year that started on Tuesday of the Common Events 585 BC - A Solar eclipse occurs as predicted by Greek philosopher and scientist Thales, while Alyattes is battling
See also
- Behavioral finance
- Equity investment
- Fictitious capital
- Financial markets
- Day trading
- George Soros
- Jesse Lauriston Livermore
- Gambling
- Seasonal traders
- Short selling
- Speculative Attack
- Stock market bubble
- Stock trader
- Tobin tax
- Tulip mania
Dictionary
speculation
-noun
- The process of thinking or meditating on a subject
- A judgment or conclusion reached by speculating
- An investment involving higher than normal risk in order to obtain a higher than normal return
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