For the village in New York, see Speculator, New York. Many speculators pay little attention to the fundamental value of a security and instead focus purely on price movements. Speculation can in principle involve any tradable good or financial instrument. With the appearance of the stock ticker machine 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 4. 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. According to Benjamin Graham in The Intelligent Investor, 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.
Speculation is condemned on ethical-moral grounds as creating money from money and thereby promoting the vices of avarice and gambling. 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. 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. With fewer players in the market, there would be a larger spread between the current bid and ask price of pork bellies. By contrast, a commodity 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.
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. 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. 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. Speculative hedge 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.
Shorting may act as a “canary in a coal mine” to stop unsustainable practices earlier and thus reduce damages and forming market bubbles. Auctions are a method of squeezing out speculators from a transaction, but they may have their own perverse effects by the winner’s curse. Speculation is often associated with economic bubbles. 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 1936, 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.