The Role of Speculation in Securities Trading

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Speculation is a human activity of imagining or anticipating responses and activities of others. The goal of any economic speculation is to obtain a financial advantage through the realization of expected future market prospects.

Financial results of speculation are always in the difference between purchasing price and selling price of a market item, net of costs of trade (transaction costs).

Successful speculation is mainly due to the early identification and exploitation of possible miscalculation of the market factors by operators on future price movements. Which are in turn distributed unequally between buyers and sellers (so-called asymmetric information). The market then corrects these misconceptions resulting in speculative gains. If the speculation fails, losses will be experienced.

In the economic field, speculation involves making decisions on the basis of a hypothetical future economic status. Thus, it is a cash bet on the future price of economic goods. If the operator obtains inside information, it is no longer a speculation but the presence of insider trading.

To speculate involves buying or selling usually in exchange of a certain quantity of a commodity, an asset finance, real estate, collectibles or derivative contract. With the hope that its price will subsequently rise so as to provide monetary gain. While accepting the risk of losing money if the development is contrary to expectations.

For example, due to bad macroeconomic fundamentals the devaluation of a given currency is expected, that is, the exchange rate against some other stable currency will change. The speculator buys the stable currency in order to exchange after the devaluation.

In this respect, one can say that the capital or foreign exchange market has re-evaluated in view of the macroeconomic data, as regards the currencies. Speculation is thus a mechanism to adjust the pricing of new information, so that the allocation of resources improves.

Certain financial instruments such as futures contracts or financial options can speculate on large amounts with a small initial amount. And also sell goods that are not yet available, which will have to be bought before the delivery date.

Speculation can manage the risk by not following the law of averages so that they can be covered through the mechanism of insurance on the basis of a calculation of probability.

Market liquidity is more important than the volumes traded, in its absence the hedging activities undertaken by those wanting to guard against risk would be rendered more difficult and expensive. Speculation is considered essential by providing liquidity.

An important economic function of speculation is transmission, given the risks of capital market business for a reasonable expected return for speculators.

 

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