What Is the Speculation Index?
The Speculation Index is computed as the ratio of the trading volume on the NYSE American (formerly the American Stock Exchange or AMEX) to that of the New York Stock Exchange (NYSE). A high level in the index may signal increased speculation among traders since the NYSE American tends to list smaller, riskier stocks than the NYSE.
As high levels of speculation occur during bull markets, the Speculation Index is often viewed as a leading indicator of market activity and sentiment.
- The Speculation Index is a measure of stock market trading volume, comparing the total trading volume of trading on NYSE American to that of the New York Stock Exchange.
- The Speculation Index is based on the assumption that the small-cap stocks that comprise the NYSE American are more risky, on average, than the large-cap stocks of the NYSE.
- The Speculation Index is a proxy for the amount of speculative trading activity in U.S. equity markets.
Understanding the Speculation Index
The Speculation Index is calculated by dividing the total trading volume of the NYSE American exchange by the total trading volume of the NYSE. It's often expressed as a percentage. The higher the percentage, the greater the speculative activity.
The basic assumption behind the Speculation Index is that the NYSE consists of relatively mature blue-chip companies, whereas the NYSE American contains smaller companies that are presumed to be riskier for investors. For this reason, proponents of the Speculation Index argue that increased investment in NYSE American companies as compared to NYSE ones represents more aggressive risk-taking by investors, and is, therefore, a proxy for the level of speculative trading activity in U.S. equity markets,
Speculation activity is important because it's usually associated with an optimistic feeling among traders and investors—which drives stock prices higher. Some analysts believe that a high Speculation Index signifies bullishness by investors. If the index gets too high, however, it may signal that the market is nearing its peak—and the beginning of the end of a bull run.
Criticism of the Speculation Index
Critics of the Speculation Index point out that since the constituents of the NYSE and NYSE American change over time, determining just how speculative the components of each index are at any given time is difficult.
Also, the Speculation Index fails to account for the fact that a growing percentage of trading activity on both exchanges consists of high-frequency trading (HFT) strategies. Because these strategies seek to exploit minute price fluctuations rather than investing based on perceived medium- or long-term misevaluations, the logic that NYSE American investors are on average more speculative than those of the NYSE may have less merit than it did in the past.
Alternatives to the Speculation Index
Some investors have developed alternative techniques for gauging market sentiment, which circumvent the limitations of the Speculation Index. One notable example is the version put forward by financial writer/podcaster Jesse Felder on his website, The Felder Report.
In a report published in February 2018, Felder presented what he dubbed a different "index of the volume of speculation." He offered series of charts demonstrating how the use of margin debt by investors has exploded in recent years, even surpassing the level reached at the peak of the now-infamous dotcom bubble. His data also revealed a negative correlation between levels of margin-based trading and subsequent three-year stock market returns.
Although this methodology differs from the traditional approach of the Speculation Index, it corroborates the commonly held view that high amounts of speculative trading could indicate that the stock market is nearing a peak.
How Do You Calculate the Speculation Index?
The speculation index is simply the daily trading volume on the NYSE American Exchange (formerly the American Stock Exchange - AMEX) over that of the NYSE itself. A higher level in this ratio is indicative of a higher degree of speculation.
What Is the Difference Between Speculation and Investing?
Investing involves putting your money to work with a positive expected return. Investors try to generate a satisfactory return on their capital by taking on an average or below-average amount of risk. Speculators instead seek to earn abnormally high returns from risky bets that can go one way or the other.
What Is the Difference Between Speculation and Gambling?
While both activities involve risk, gambling refers to games of chance and will typically have negative expected returns. In other words, gambling is pure luck, and the house has an advantage. With speculation, there may also be a high risk of loss, but decisions are based on a company's fundamentals and future performance. Speculators are therefore making educated decisions.