Speculative Flow

What is Speculative Flow

Speculative flow is the movement of hot money into shares of a sector or specific company or an asset class in an attempt to earn short-term gains. Speculative flow can be sustained or short-lived, and if large enough, the increased demand will create upward pressure on the price of the securities where the money is flowing.

Understanding Speculative Flow

Speculation should not be confused with informed investing. Speculators typically know very little about the fundamentals of a company or a sector, or the underlying drivers of a particular asset class. However, if they believe something will go up, they may place their bets on the object of their adoration. Other like-minded speculators may catch wind of a hot trade and join in, adding to the speculative flow of money into a security — a stock, sector ETF, junk bonds, a foreign currency, cryptocurrency, etc.

While speculative flow generally has a bad rep as far as its effects are concerned, it can also prove to be a force for good. For example, speculative flow can provide liquidity to nascent companies or sectors that are struggling to reach their market potential. An influx of money can help such sectors scale and build out the necessary infrastructure and marketing strategy necessary to gain new audiences. Speculative flow can have the same effect on developing or underdeveloped economies, enabling them to kickstart growth.

Example of Speculative Flow

On any given trading day, there are speculative flows to be found in all corners of the markets. The ones reported in the news happen to be the more interesting cases involving names or asset classes that many people have familiarity with. Take Twitter, for example, which went public in 2013. Shortly after it hit the market, massive speculative flow took the stock from its IPO price of $26 per share to close to $45 by the end of its first trading day. Speculative flows into the stock regularly occur when the rumor mill spins that the company will be bought.

Another example of an asset class that is prone to speculative flow — this one global and gargantuan — is crude oil. When traders expect Middle East tensions to erupt, OPEC to stick together, or supply of oil to otherwise be constrained, they may aggressively buy crude oil futures contracts in an attempt to reap short-term profits from a potential spike in oil prices.

Another example of speculation occurred during the housing crisis of 2006. Speculators pumped money into the housing market and pushed up supply of available housing stock in anticipation of gains. Their reasoning for a boom in the housing market was not based on present economic reality. According to research, it was anchored, in part, on extrapolation from past housing market changes. However, the script was altered in 2006 and the housing glut did not transform into a boom or profits. Instead it led to a crash.