Speculation - Term Overview

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Speculation is the set of commercial or financial operations that aim to obtain an economic benefit. To do this, taking advantage of price fluctuations over time, by investing capital. That is, buy low and sell high.

The main characteristic is that the speculator will never seek to enjoy the good or product in which he invests, unlike other investments. The only thing the speculator pursues, with his investment, is to obtain an economic advantage. Taking advantage of the fluctuations in the price of that good. That is, its main objective is to obtain economic benefit.

Speculators try to guess what the future behavior of a price will be. In this way, being able, later, to enter the market based on what is expected. For example, suppose a speculator predicts that the wheat crop will be worse than expected. Anticipating, therefore, that the price will rise. Thus, the speculator will act in the futures market on wheat, buying contracts and waiting for the price of wheat to rise. In this way, making a profit.

It could be said that the activity of speculation doesn't guarantee an absolute return. In fact, it carries a significant risk of losing some or all of the money invested. If, when making an investment, the market moves in the opposite direction to what the speculator had predicted, the speculator will suffer a loss. Therefore, to speculate it's necessary to have knowledge about what is being done, in order to benefit from the situation.

Advantages of speculation

Main advantages of speculation for the economy:

- Speculators lock in prices: Continuing with the previous example, let's imagine that a wheat producer predicts that global wheat crops will be better than expected this year and that the price will fall. If you want to protect yourself from that price drop and make sure that you are going to sell the wheat at the current price, you can go to the futures market and sell the futures contracts to the speculator, protecting yourself from the risk of a price drop. In the absence of speculation, the producer in the example could decide not to invest more money in that production because it's not going to be profitable, eventually running out of those raw materials.
- Speculators generate vehicles to protect themselves from price fluctuations: If speculation didn't exist, the previous producer would hardly have mechanisms to protect itself from the drop in wheat prices.
- Speculation contributes to the liquidity of the markets and the formation of efficient prices. More liquidity in the market means there is more supply and demand, which will help to set a more efficient price and allow the markets to function properly. The liquidity will also guarantee a greater speed and ease of carrying out the transaction. What allows and ensures that prices are efficient.

Criticism of speculation

There are some economists who consider price fluctuation a market failure that must be corrected through state intervention. The latter would be an inconvenience for efficient price formation and resource allocation, since prices depend on supply and demand. Intervening in the markets reduces the existing liquidity and therefore increases the financing costs of companies and States. In addition, it means creating inefficient markets in which it's not profitable to invest and in which there isn't enough competition to make it easier for prices to fall, or competition to force the quality of products and services to improve.

Another major criticism of speculation is that speculators are to blame for prices becoming more expensive. If this were true, it would mean that the speculator knows in advance that the real price of the asset is going to rise, which is unpredictable looking only at the price variation. On the contrary, speculation guarantees price stability by increasing the supply and demand of the asset, reduces volatility and ensures that the transaction will be carried out at the existing market price, because there are many speculators willing to buy and sell. Therefore, speculation is necessary for there to be agents willing to assume the risk of price fluctuations.

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