Speculation

Sometimes speculative purchasing can cause particular prices to rise above their "true worth" simply because the speculative purchasing is artificially increasing the demand. Speculative selling can also cause prices to fall below "true value" in a similar fashion. In some situations price rises due to speculative purchasing cause further speculative purchasing in the hope that the price will continue to rise. This creates a positive feedback loop in which prices rise dramatically above the underlying "value" or "worth" of the items. This is known as an economic bubble (or sometimes a speculative bubble). Such a period of increasing speculative purchasing is very often followed by one of speculative selling in which the price falls in a crash (see Stock market crash). This is often even more dramatic than the period of rising prices.

Speculators are comically pictured as speculating in pork bellies (in which a real market and speculators exist) and such and often losing their shirts or making a fortune upon small market changes. Speculation exists especially in futures which involve leverage that can transform a small market movement into a huge gain or loss.

Most non-professional traders lose money on speculation, those that do make money tend to become professional. Occasionally some dramatic event will occur such as the effort of the Hunts to corner the silver market or the currency speculations of George Soros.

The role of speculators in a market economy are to absorb risk and to provide liquidity in the marketplace for the chance of monetary reward. For example, if there were no speculators in a certain market, say in pork bellies, the only participants in that market would be the producers (pig farmers) and consumers (pork dealers). With fewer players in the market, there would be a larger spread between the current bid and ask price of pork bellies. Any new entrant in the market who wants to either buy or sell pork bellies will be forced to accept an illiquid market and market prices that have a large bid-ask spread. Speculators provide trading volume and liquidity. In exchange for the potential for great reward, speculators carry a significant proportion of the risk in any market.

Many current "investors" in the stock market are actually speculators, with people betting on a gain in price "buy low sell high" and many companies implicitly participating by not issuing dividends. There exist companies where the main goal of the CEO appears to be increasing the stock price rather than making a profit.

See also: Equity investment, Investment, Financial markets, Stock market bubble, Tobin tax, Tulipomania

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