What is Speculation?

Speculation is a type of financial activity that involves using money in a way that guarantees neither the principal or any return, either due to a lack of research or an inherently risky situation. Investment is similar to speculation, though it typically involves situations where there is a reasonable expectation of a return on the original principal. It is possible to speculate on virtually anything that involves a monetary transaction, including real estate, financial instruments, commodities, and collectible goods. Speculation is often attractive since it can result in a potentially large return, though it is dangerous since even the original principal can be lost.

The main difference between investment and speculation is risk. Putting money in a savings account or certificate of deposit is a relatively safe investment, since both the principal and a modest return can typically be expected. Activities such as buying stocks are often looked on as investing, though the inherently risky nature of the transaction means that this activity is actually speculation. It is possible, however, to invest in the stock market relatively safely by diversifying and choosing a variety of different instruments.

Speculators can offer a number of benefits to the markets that they participate in. By infusing cash into a market, speculators create liquidity that would not otherwise exist. Without speculators, the only two participants in any given market would be the producers and the consumers. This can lead to the sort of stagnation that benefits neither of these parties. The speculator can also assume risk for a producer by purchasing a commodity prior to its production, thereby helping to increase supply beyond the level it might otherwise have reached.

There can also be adverse effects on a market caused by speculators, especially if a large number of them are acting on incorrect or incomplete information. The price of a commodity can be driven artificially high in a sort of feedback loop, which can lead to an economic bubble. This can be incredibly damaging to markets or entire economies.

Currency speculation is one particular activity that can effectively drive the perceived value of the pairs being traded up or down. Commodities markets, such as oil speculation, can also have wide ranging effects, as the speculative buying and selling drives prices one way or the other. Activities such as these are sometimes seen as damaging, though they are often thought of as being necessary for many aspects of business and trade.