A:

A speculator is anyone who trades derivatives, commodities, bonds, equities or currencies with higher-than-average risk in return for higher-than-average profit potential. Speculators can include individual investors, institutional investors, hedge funds, pension funds, investment banks, index funds and exchange-traded funds (ETFs), and can participate in any financial market. The key role of speculators in the market place is to add liquidity by providing buyers and sellers with partners for their desired trades. Liquidity maintains order within the financial markets and is the key driver behind efficient exchanges. Speculators add huge amounts of money to the markets, and the more money they invest in the market, the more liquid it becomes. An efficient market (very liquid) allows for buyers and sellers to trade with one another with relative ease without causing large shifts in prices.

Speculators in the past have come under much scrutiny for the unpredictability of the markets, namely the sharp peaks and valleys associated with prices in the commodity markets. While speculators have been labeled as greedy and irresponsible during times of high gas and food prices or sudden currency devaluations, it is important to mention that speculators are not solely to blame for these sharp increases or decreases in value.

Financial systems are guided by countless micro and macroeconomic factors, along with the movement of financial markets. Increased demand for commodities, equities and currencies will almost certainly drive the value of these items upward, and with increased demand comes more buyers. Without a comparable amount of sellers in the marketplace it becomes illiquid, creating an inefficient marketplace which could lead to even higher prices. Speculators, by taking on the increased risk of adding large sums of money to the market place to create liquidity, demand increased profits for those risks. It has been argued that speculators actually have a calming effect on the market place due to their large positions and constant need to balance those positions. As well, speculators allow countless individuals and institutions to protect their investments by providing a willing trading partner in hedging strategies. (For more on commodities, read An Overview Of Commodities Trading.)

Although speculators are an integral part of the financial landscape, it should be noted that there have been many cases of speculators manipulating the markets illegally to profit from the results. Such speculation can be difficult to monitor and can drastically affect the financial system. Speculators are a very important component to the marketplace, but speculators who partake in "excessive speculation" can definitely have a destabilizing effect on the financial system.

To learn about speculating read our related article Arbitrage Squeezes Profit From Market Inefficiency.

RELATED FAQS

  1. Can an investor buy leveraged ETFs that track the automotive sector?

    Learn about the main exchange-traded fund that tracks the automotive sector and how option strategies can be used for stocks ...
  2. Why should I consider buying an option if it's out-of-the-money?

    Learn when a trader may want to buy out-of-the-money options either for hedging purposes or to profit if the underlying stock ...
  3. How do traders use out-of-the-money options to hedge?

    Learn a couple of simple option trading strategies that traders can use to hedge an existing market position and protect ...
  4. What are some examples of smart beta ETFs that use passive and active management?

    Learn about smart beta investment strategies and discover examples of smart beta exchange-traded funds that use both passive ...
RELATED TERMS
  1. Precedent Transaction Analysis

    A valuation method in which the prices paid for similar companies ...
  2. Bjerksund-Stensland Model

    A closed-form option pricing model used to calculate the price ...
  3. Exchange-Traded Mutual Funds (ETMF)

    Investopedia explains the definition of exchange-traded mutual ...
  4. Cape Cod Method

    A method used to calculate loss reserves that uses weights proportional ...
  5. Kenney Rule

    A ratio of an insurance company’s unearned premiums to its policyholders’ ...
  6. Discounted Future Earnings

    A method of valuation to estimate the value of a firm.

You May Also Like

Related Articles
  1. Professionals

    Worried About Stocks? Try on Convertibles

  2. Stock Analysis

    Playing Rising Rates with Ultra-Short ...

  3. Chart Advisor

    How Investors are Profiting from Cyber ...

  4. Professionals

    Indexing vs. Stock Picking: Which is ...

  5. Chart Advisor

    ChartAdvisor for June 26 2015

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!