Speculation

A description of function rather than of instrument, size or horizon. The same futures contract in the same market is a hedge for the farmer who grew the crop and a speculation for whoever takes the other side, and neither party can tell from the contract alone which is which. The distinguishing question is whether the position offsets an exposure that exists elsewhere, or creates one that did not exist before.

Markets are structured around the distinction because it explains who is present. Hedgers need someone to accept the risk they are transferring, and the participants willing to do that in size, at short notice, are speculators, whose activity is most of the volume in most listed derivative markets. The categories in the Commitment of Traders report are an attempt to count the two groups separately, and they classify the reporting entity rather than the intent behind a position, which is why a hedge and a bet can end up in the same bucket.

Whether the activity improves markets or harms them is one of the oldest live arguments in economics. One side holds that speculation moves prices towards fundamental value faster and provides the liquidity hedgers rely on; the other holds that it widens moves and can detach a price from the physical market for a time. Position limits, transparency requirements and financial transaction taxes are all policy expressions of the second view, and the evidence has not settled the question. The ordinary use of the word also carries a moral colouring that the technical definition does not.