What is Speculation?

Speculation is like investing all of your money into a plot of land because you think you’ll find gold…

If you buy a piece of property that really does have gold, your investment could have a big pay off. But if there’s no gold, you’d likely lose big. Speculation is when investors put their money toward something that’s often a long-shot, but that could potentially earn them a lot of money.

Speculation is the act of investing in opportunities with a high risk of loss, but also with the potential for significant financial gain.

Like other investors, speculators invest with the hopes that they’ll be able to sell an asset for more than they bought it. But while many investors intentionally put their money into low-risk investments with a good chance of profit, speculators often opt for opportunities with greater risk for loss, but a greater potential return. In the eyes of a speculator, the potential reward outweighs the risk. Speculation often involves trading in particularly volatile markets.

Suppose a friend of yours was trying to start a business that required a lot of capital. There are already many competitors in the business, which likely means it’s going to be difficult to make a new business stand out. But if your friend is successful, the company will probably make a lot of money. In other words, investing in the company would be very risky, but potentially very profitable. This is an example of speculation.

Speculators often participate in volatile investing. They try to guess which way the price of an asset is going to go and how much the price will move. Speculators either try to short the market by selling an asset right before the market price plummets, or they try to get in when prices are low, hoping they’ll increase shortly thereafter.

Speculators try to buy an asset when the price is low in the hopes that it will dramatically increase. In a way, this doesn’t seem so different from a typical long-term investor. But speculators don’t generally have an interest in holding the assets they’re buying — They usually buy and sell as soon as the price goes up. Some speculation involves a quick turnaround, such as day traders who buy and sell stocks each day. Often, speculation involves holding an investment for less than one year. In some cases, however, it might be more of a longer-term speculation, but with the same high-risk-high-reward scenario.

Speculation differs from other investment approaches in two primary ways: It involves a great amount of risk, and the potential for substantial gains. A speculator might be more willing to jump on opportunities that many other investors wouldn’t — They’re willing to lose money, because they think the potential profit overshadows the risk.

Speculators generally try to make money by buying when prices are low and selling when prices are high. Rather than buying investments and holding them for long periods of time, speculators try to take advantage of short-term volatility in the market. Speculation generally involves trying to profit from a large market swing. There are two primary types of speculation.

A bear speculator expects that the price of a particular stock will be falling soon and sells before that happens. One past example is Jess Livermore, an American day trader who sold $100M of investments right before the 1929 stock market crash.

A bull speculator buys a particular stock because they anticipate it will increase substantially — At which point they can sell the stock for a profit.

Speculation is the act of making calculated investments in high-risk opportunities with the chance of a big payoff. A speculative investment refers to the investment itself. These investments carry a particularly high level of risk, but that also opens the door for a substantial profit. Speculative investments tend to have higher volatility, meaning they experience frequent price fluctuations.

Angel investors and venture capitalists often choose speculative investments. The idea is that the high risk and chance of making the wrong bet are worth taking to potentially reap big returns. Think of a startup tech company, foreign currencies, and futures contracts (agreements that allow an investor to buy or sell a security in the future).

A bond is a type of financial instrument that corporations and governments can issue to raise capital when they need it. When you invest in bonds, you’re basically lending that entity money. And just like you pay interest on a loan from the bank, the bond issuer pays you interest on its debt.

Different bonds carry different levels of risk for investors. Bonds that the United States Treasury Department issues are generally considered a relatively low-risk investment, since they’re backed by the federal government. In the case of a corporate bond, it comes down to the credit rating of the company.

Bond speculation involves buying junk bonds, which are typically issued by companies with low credit ratings. Junk bonds also tend to have a higher coupon rate (aka interest rate), meaning the investor has the potential to make more money. All of this means that junk bonds carry a higher risk of the issuer defaulting.

Speculative trading has both upsides and downsides, not just for the investor, but also for the economy as a whole. For an individual investor, speculation involves putting money in high-risk opportunities where the chances of losing that money are higher than those of other investments. For this reason, speculation is an investment strategy that, for many investors, may not be worth the risk. For others, the potential gains may be big enough to overshadow the high risk of loss.

Speculation can also have an effect on the economy as a whole. For one, speculators can help to create liquidity because they buy and sell stocks regularly. Speculators also allow companies the opportunity to get financing when they might not otherwise be able to. A start-up, for example, might struggle to find other investments because it doesn’t yet have a track record, whereas speculators might be more willing to invest.

Speculation can have negative economic impacts as well. The action of speculators can cause the price of an asset to move purely as a result of the speculator’s actions and not any other market cause. Imagine that a group of speculators feared a particular stock price would soon fall, so they sell off their shares. If enough people sold their shares at once, that may cause the stock price to fall. The same can happen when speculators buy — It can create a bubble, leading to an artificially higher price.