What is a Speculator

A speculator utilizes strategies and typically a shorter time frame in an attempt to outperform traditional longer-term investors. Speculators take on risk, especially with respect to anticipating future price movements, in the hope of making gains that are large enough to offset the risk.

Speculators that take on excessive risk typically don't last long. Speculators exert control over long-term risks by employing various strategies such as position sizing, stop loss orders, and monitoring the statistics of their trading performance. Speculators are typically sophisticated risk-taking individuals with expertise in the markets in which they are trading. 

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Speculation

Basics of Speculators

Speculators attempt to predict price changes and extract profit from the price moves in an asset. They may utilize leverage to magnify returns (and losses), although this is a personal choice of the individual.

There are different types of speculators in a market. For example, individual traders can be speculators, if they purchase a financial instrument for short periods of time with intentions of profiting from its price changes. Market makers can also be considered speculators because they take the opposite position to market participants and profit from the difference in bid and ask spreads. Prop shops or proprietary trading firms can also be considered speculators because they use leverage to purchase securities and make profits from changes in their price.

Normally, speculators operate in a shorter time frame than a traditional investor.

For example, a person may call themself an investor if they buy 20 strong companies and plan to hold those stocks for at least 10 years, assuming the companies continue to perform well. A speculator, on the other hand, may use all their portfolio capital to buy five stocks, or several futures contracts, expecting them to rise over the next few days, weeks, or months. Speculators typically utilize trading strategies that tell them when to buy, when to sell (at a loss or profit), and how big of a position to take.

Principles Behind Speculation

Speculation sometimes gets confused with gambling. There is an important distinction, though. If a trader is using untested methods to trade, often based on hunches or feelings, it is highly likely they are gambling. If gambling, the trader is likely to lose over the long-run. Profitable speculation takes a lot of work, but with proper strategies, it is possible to gain a reliable edge in the marketplace.

Profitable speculators look for repeating patterns in the marketplace. They look for commonalities between many rising and falling prices, in an attempt to use that information to profit from future ups and downs in price. It is detailed work, and because prices are always moving and there are nearly infinite variables to consider, each speculator often develops their own unique way of trading.

Key Takeaways

  • Speculators are sophisticated investors or traders who purchase assets for short periods of time and employ strategies in order to profit from changes in its price.
  • Speculators are important to markets because they bring liquidity and assume market risk. Conversely, they can also have a negative impact on markets, when their trading actions result in a speculative bubble that drives up an asset's price to unsustainable levels.

Speculators' Impact on the Market

If a speculator believes that a particular asset is going to increase in value, they may choose to purchase as much of the asset as possible. This activity, based on the perceived increase in demand, drives up the price of the particular asset. If this activity is seen across the market as a positive sign, it may cause other traders to purchase the asset as well, further elevating the price. This can result in a speculative bubble, where the speculator activity has driven the price of an asset above its true value.

The same can be seen in reverse. If a speculator believes a downward trend is on the horizon, or that an asset is currently overpriced, they sell as much of the asset as possible while prices are higher. This act begins to lower the price of the asset. If other traders act similarly, the price will continue to fall until the activity in the market stabilizes.

In this way, even many investors become speculators from time to time. They get caught up in the frenzy of the big ups and down. While they may have initiated their position with the intention of being long-term investors, if they start to buy and sell solely because they think other people are buying or selling, they have entered the realm speculation—possibly even gambling, if they are unsure of what they are doing—as opposed to investing.