What is speculation and example of Speculation

What is speculation and example of Speculation

Speculation or a speculative investment is one that carries a high degree of risk wherein the buyer focuses on the price fluctuations. In a given process of speculation, the investor purchases a tradable good or financial instrument hoping to profit from the changes in the market value. The investor making a speculative investment is called as a speculator. A speculative investor is less concerned about the basic value of security as his or her focus is more on the price movements. The investor also is not at all concerned about the annual income the asset might bring in the form of dividends and interests. What interests this kind of investor is the price for which he or she can sell the given financial instrument on a future date.

Where do speculative investments happen?

Most popularly, speculative investments are seen in the markets concerned with stocks, real estate, fine art, antiques, commodities and collectibles. It is very important to know the difference between saving, investment, and a speculative investment.

The stock ticker machine debuted in the year 1867 and after that the traders were not required to be present on the stock exchange floor physically. Starting from those times till the end of 1920s, stock speculations grew exponentially.

Understanding the difference between investment and speculative investment

An act of investment refers to the application of resources in order to make more money. It can also refer to the buying of goods that are not consumed immediately, but are held to create wealth in future. In typical cases, investments provide income as well as growth.

An expert defined speculative investor as, “A trader who does not hedge, but who trades with the objective of achieving profits through the successful anticipation of price movements.”

As per the definition found in the Cambridge Dictionaries Online, a speculative investment is “An investment that carries a high level of risk of loss, or the activity of investing in these types of investment.”

To put the difference in simple words, a speculative investment is only about growth whereas an investment is about income plus growth.

Speculative investment example

Technically speaking, an investor who buys or shorts a security expecting a favorable price change is a speculator. For example, if a speculator believes that the stock of a company called X is over-priced, he or she might short the stock and wait for a favorable time when the price falls and then sells it to make a profit. One can speculate on any security. However, the most common platforms for speculative investments are commodities, derivatives and futures.

To understand speculation in a better way, it is important to know the difference between speculation and hedging. Let us look at an example here. Consider, as part of your investment portfolio, you have bought the shares of a company X that deals with autos. Due to the cyclical nature of the auto industry, the shares of this company might decline if the economy deteriorates. In order to protect this investment, you might choose to buy defensive stocks like basic necessities (toothpaste for instance). At times of economic clumps, these stocks will increase in their value which can offset the loss you might incur due to the loss of value of X company’s stocks.

A speculator will never adopt this strategy since if he had purchased the stocks of a food company, he will choose to do it due to his firm belief that the stock is most likely to increase.