Speculation

Speculation, buying and selling with a view to making a profit. In general, the term is used for the activity of those who trade in the commodities and currency markets for their own sake, as distinct from those who trade in them because their business requires that they do—a manufacturer of instant coffee or an importer who has agreed to pay for goods in a foreign currency, for example. Speculators live by fluctuations in commodity and currency prices. They aim to make money by buying at the spot price in anticipation of a price rise. They also sell in the futures market, hoping that they will be able to buy the commodity or currency on the spot market at a lower price before they have to complete the “future” deal.

To be successful, speculators rely on a number of things. Knowledge is one; for example, that the coffee harvest is going to be bad. Contacts and research are helpful here, but equally important is the judgement a speculator makes when possessed of certain knowledge; how much coffee prices are likely to rise as a result of the bad harvest, for example. Speculators must also make judgements by taking a view on events; for example, the likelihood of or the timing of an adjustment in interest rates, which will affect exchange rates. Of course, speculative activity itself influences the market, as it is one determinant of demand. In 1992, for example, some speculators made billions of pounds as a result of taking the view that the pound sterling was overvalued. The pressure on sterling became so great that the United Kingdom withdrew from the exchange rate mechanism (ERM) of the European Monetary System (EMS) and the value of the pound fell to the level that (clever) speculators had predicted. Continued speculation concerning some of the remaining currencies in the ERM almost caused it to collapse in 1993, and resulted in major changes to the way the ERM operates. Although “speculator” is often used as a term of abuse, speculation is just a form of trading in which traders expose themselves to uncovered risk. Unlike other traders, speculators do not protect themselves by hedging, the method of matching spot and future contracts used by those who want to protect themselves from fluctuations in exchange rates or commodity prices.