Debt Dictionary


Investment Dictionary -> Speculation

Speculation refers to the selection of high risk investments with the aim to profit from the anticipated movement of prices. It is not just a form of gambling as speculators take decisions on the basis of certain information before their risky endeavor. On the other hand, speculation should not be mistaken with traditional investment due to the increased amount of risks. Some investors apply a hedging strategy in a combination with the speculative investments.

The difference between speculation and investment is what articulates the meaning of the term. Even long-term investors, who buy and hold assets for many years, may be considered speculators, except for those who are earning income without selling at a profit.

Speculators typically stand out as short holders. They are willing to take short or long positions fast. Speculation exists in a wide range of financial decisions- from placing a bet on a horse to the actual purchase of a house. The modern market calls it "ubiquitous speculation."

At times, profit turns out insignificant or speculation does not satisfy current demand. Then, speculation comes with the hope to profit from goods and services that are scarce. The purchase raises their price and ensures long lasting supply. When the price goes sufficiently high, the speculators start to sell. This, on the other hand, reduces the price and encourages both consumption and export. The surplus is reduced in this manner.

Speculators serve the market purposes, too. In a hope for profit, they risk their own capital thus adding liquidity to the market.
Speculation has its side effects. It can result in a difference between prices and their fair value if there is misinformation on the market. When a purchase is speculative, it pushes the prices over their true value and thus increases demand in artificial way. Speculative sale has the opposite effect. The price falls significantly and leads to crashes.

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