Speculation - Definition, What is Speculation, Advantages of Speculation, and Latest News - ClearTax (2024)

What is speculation?

Speculation (also known as speculative trading) is a financial term that refers to the act of purchasing an asset (a commodity, good or real estate) that has a substantial risk of losing value but also holds the hope of gaining value in the near future. An investor who's into speculative trading purchases an asset in an attempt to gain profit from small fluctuations in the market. These are high-risk, high gain investments that are made for a short amount of time and once the investor gets the desired profit, the investment is sold. For example- An investor who invests in foreign currency buys some currency in the hopes of selling it at an appreciated rate when market fluctuations happen. This type of speculation is known as currency speculation.

How does speculation work?

Without the prospect of huge gains, there would be next to no motivation to be a part of speculation trading. There’s a thin line that separates speculation and simple investment which makes it pretty difficult for the market players to differentiate between them. Real estate is the perfect example of this. Buying real estate for the purpose of renting it out is considered investing but buying several apartments with the intention of earning a quick profit by reselling them after a short duration. Speculation traders provide market liquidity and can narrow the difference between the bid price and the asking price for an asset in the market. Speculative trading not only keeps the rampant bullishness in check but also prevents the risk of the formation of asset price bubbles through betting on successful outcomes.

Types of speculative transactions

There are a number of transactions that facilitate speculative dealing which can be classified into the following types:

• Option DealingsOption dealing is an arrangement of the right to buy or sell a specific number of securities within a prescribed time at a price determined earlier. Options dealing is a highly risky transaction in securities as their prices change very frequently and very heavily. Option dealings can be further classified into Call, Put and Call & Put option dealings.
• Margin TradingIn margin trading, the client opens an account with the broker by depositing a certain amount of securities or cash. The client purchases securities with the funds that he borrowed from the broker and then the price difference is credited or debited to or from the client's account.
• Blank TransferThis is a transfer method in which securities are transferred without mentioning the name of the transferee. With this process, shares can be transferred any number of times and finally the transferee who wanted the shares can get them registered under his/her name saving stamp duty that is charged during transfers.
• ArbitrageIn Arbitrage, speculators earn profit out of the differences in prices of a security in two different markets. This process is known to level the pricing of that security in those two markets. It is a highly specialized speculative activity that requires skills.
• Wash SalesWash sales are used to create artificial demand in the market which will lead to a rise in prices. This is done by selling securities and then buying the same securities at a higher price. Wash sales are sometimes also called fictitious transactions as the only purpose of these transactions is to jack up the prices.
• Carry Over or Budla TransactionsCarry over transactions are usually done when the prices of a particular financial instrument move against what the speculator expected. This happens in the case of forward delivery contracts, the contract is settled on the next settlement date only if both parties agree to it.
• CorneringA corner refers to the condition of the market in which the entire supply of a particular security is controlled by an individual or a group of individuals. The speculators enter such a market and make purchasing contracts with the bears until they have a substantial amount of the securities available in the market thus making them go out of the market. In these cases, bears will struggle to make the delivery on the fixed date. This process turns a bear into a lame duck.
• Rigging the MarketRigging as the name suggests means forcing the price of a security in the market to go up. This process is generally carried out by the Bulls in the market. When the security reaches the desired prices they sell their securities and earn a substantial profit.

Speculators and their types

A speculator is an individual or entity that attempts to gain profit from small fluctuations in the prices of financial assets over a short time. Speculators can range from individuals from the household sector to entities from corporate and foreign sectors as well as banks. Speculators use their own money (or sometimes, borrowed money) and invest it in bonds, equity, money market, foreign exchange and other financial instruments for a short period of time. Some people might confuse speculation with gambling but there's a huge difference between them. Speculators take on risks in order to earn a risk premium but gamblers risk even without a risk premium making speculation trading less risky than good old gambling. Now that you know who speculators are, it's time to know what type of speculators you might come across in the market.

*BullIn simple words, a bull is an optimist speculator. He/She is the kind of speculator who gains profits when the prices of the bought assets increase. A bullish speculator buys undervalued stocks and waits for their value to rise, so they can be resold for a profit. Bullish speculations are typical of buy and hold investments that's why bullish positions are also known as long positions. For example, the stock is $10 in value, a bullish speculator would buy it when its value has fallen down to $8 and would hold it until the stock reaches $11 thus earning him a profit of $3.* BearA bear is a pessimist speculator, he/she gains profit when there's a fall in the value of that asset. Bearish positions are called short positions. In this, the speculator borrows securities and sells them to an available buyer in the hopes of buying them back at a price lower than what the securities were originally sold for. This way, the speculator can return the securities back to the borrower while also earning a profit for himself/herself. For example, a speculator expects the value of a particular share to fall from $10 to $8. So, he/she will borrow some shares and sell them at the current price of $10 and when the prices go down to $8 he will buy them back at $8 earning him a profit.* StagA stag is a type of cautious speculator who only deals with new shares of a company with the intent of selling them for a profit at a later date. Instead of anticipating the market trend on their own, they use thorough technical analysis and tape readings to predict the market trend and make purchases accordingly thus giving them the name cautious speculators.* Lame DuckLame Duck is a type of speculator who is on the verge of going bankrupt because of his/her bad trades. In most cases, a lame duck is a bear speculator who is unable to get the borrowed securities at a lower price and the person is said to be struggling like a lame duck.