Understanding Speculators: Strategies and Risks in the Market

A speculator is an individual or firm that, as the name suggests, speculates – or guesses – that the price of securities will go up or down and trades the securitiesMarketable SecuritiesMarketable securities are unrestricted short-term financial instruments that are issued either for equity securities or for debt securities of a publicly listed company. The issuing company creates these instruments for the express purpose of raising funds to further finance business activities and expansion. based on their speculation. Speculators are also people who create fortunes and start, fund, or help to grow businesses. Venture capitalists, private equity firmsTop 10 Private Equity FirmsWho are the top 10 private equity firms in the world? Our list of the top ten largest PE firms, sorted by total capital raised. Common strategies within P.E. include leveraged buyouts (LBO), venture capital, growth capital, distressed investments and mezzanine capital., and hedge funds are all speculators.

Notable speculators include legendary traders such as Paul Tudor Jones, George Soros, and Jesse Livermore.

Speculators vs. Investors

There is really no hardline distinction between “investors” and “speculators.” Both make investments. The primary difference between investors and speculators is a matter of attitude and motivation. Generally speaking, those who are considered investors tend to make long-term, “buy and hold” investments with moderate risk, while speculators tend to be more active in their investments. They are typically more willing to take on a greater level of risk in return for a potentially higher return on investment.

Speculators analyze companies in depth to determine how well they are functioning, what their profit levels are, if they are poised to make short or long-term growth, if their stocks are under or overvalued, and how to trade shares of the companies’ stocks based on all of this data.

Speculation is Not Merely Gambling

A common misperception is that speculators are merely gamblers who take wild chances, just hoping they are right. That is not the case at all.

“Modern usage has made the term speculator a synonym for gambler…the word comes from the Latin ‘speculari,’ which means to spy out and observe. I have defined a speculator as a man who observes the future and acts before it occurs. To be able to do this successfully…three things are necessary: First, one must get the facts of a situation…Second, one must form a judgment as to what those facts portend. Third, one must act in time, before it is too late…If action is delayed until the need is apparent to everyone, it will be too late.” – Bernard Baruch

The last part of that quote from Bernard Baruch notes the additional risk that speculators must be willing to take – acting before future price direction or the fortunes of a company is pretty much clear to everyone in the investing world. Speculators take calculated risks based on educated guesses – they don’t just make blind bets. Speculation often entails following one of the adages of Warren Buffet – “Be fearful when others are greedy” (and be greedy when others are fearful).

Speculators don’t expect to be right every time, but they are willing to accept occasional losses in pursuit of overall higher profits. For example, private equity firms don’t assume that every business investment they make will be profitable. Rather, they believe that their ability to carefully analyze businesses and markets will ultimately make them profitable overall.

The Effects of Speculation on the Markets and the Economy

Speculators tend to receive a bad reputation in the financial markets, often being accused of manipulating markets, causing market crashes2010 Flash CrashThe 2010 Flash Crash is the market crash that occurred on May 6, 2010. During the 2010 crash, leading US stock indices, including the Dow, or driving security prices to the extremes. In fact, speculators, by virtue of more actively trading the markets, provide key liquidity that makes buying and selling securities easier for everyone. The speculators’ active trading is actually more likely to prevent than to cause market extremes. This is because active buying and selling tends to prevent market prices from extending too far either up or down.

The markets wouldn’t exist in their current state without speculators, and it would be much more difficult for new businesses to secure funding. Because of their willingness to perform research and careful analysis, and then take calculated risks, speculators serve an important purpose. However, speculation is best left to individuals or firms with a high risk tolerance and the financial means to withstand multiple losses before seeing any profits.

Related Readings

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