Speculations in Stock and Types

Speculation is an important function of the stock exchange. Speculation means purchase or sale of a commodity with a view to earning profit from future price changes.

The word speculation is derived from the Latin word speculare which means to look at from a distance.

Thus all specula­tion represents an attempt on the part of man to peep into the future out of the window of the present. When a speculator anticipates that the price of a commodity is going to rise, he will buy it for selling in future at a profit.

Similarly when the speculator anticipates that the price of commodity is going to fall, he will sell it with a view to buying in the future at lower prices. Thus the speculator anticipates all changes in prices and hopes to earn profits out of it. A speculator is a dealer not in goods but in risks.

There are two types of speculation simple or competitive speculation and aggressive or monopo­listic speculation. A person who does not have any influence in the market price but who believes that the price is going to rise or fall independently of his own actions and who buys or sells in an attempt to make profit is a simple or competitive specula­tor.

The competitive speculator, if he is successful, buys cheap and sells dear and thereby makes profit for him-self. But by his actions he shifts goods from points where they are relatively plentiful to others where they are relatively scarce and thereby renders a great service to the society.

When he buys he tends to raise the price conferring a benefit on those from whom he buys; when he sells he tends to lower the price conferring a benefit on those to whom he sells.

By bidding up the price when it is low, he induces other members of the society to consume less and by lowering the price when it is high; he induces other members of the society to consume more. Thus competitive speculation improves upon the distribution of consumption over time.

If there is only one speculator, the whole of the gain from buying cheap and selling dear will be pocketed by him. If there are many speculators they will turn the price against themselves so that their share of the gain becomes relatively small.

If there are enough speculators and if they make cor­rect guesses, the whole of speculative gain might disappear and all the benefits will accrue to con­sumers. This is what is meant by the phrase “per­fect speculation kills itself”.

Speculation should not be confused with gam­bling. Gambling is a bad thing because it involves a sterile transfer of money between individuals, cre­ating no new value. While creating no new value gambling does nevertheless absorb time and re­sources. Gamblers try to make a quick profit by assuming unnecessary risks. They often themselves deliberately create the risks which they bear.

On the other hand a speculator assumes necessary and natural risks. There is a risk in production which must be assumed by somebody if production is to run smoothly. In other words, speculation leads people to take up business dealings which carry risks but it does not encourage people to engage in a blind search from quick and easy gain.

That is why gambling is condemned as anti-social but speculation is considered useful to the producers.

Functions of Speculation:

Speculators perform many important func­tions:

• First, speculators promote stability of prices by reducing the gap between demand and supply. If at a particular point of time, there is an excess supply of a commodity and the price becomes low, the speculator buys it and holds it for sale in the future when the commodity will be in short sup­ply.

Such action reduces the present supply and prevents prices from falling as much as they would have and increases the future supply thus prevent­ing prices from rising then as high as they would otherwise have. Thus, as a result of the functions of the speculators, the range of price fluctuations becomes less.

• Secondly, speculators reduce the risks of pro­duction by enabling manufacturers to buy raw materials in the future at current prices. Modern production organisation involves risks. In primi­tive communities, there were practically no risks because each man produced for himself and con­sumed what he produced.

But in a modern society production is carried on in anticipation of future demand. All types of productive activity involve risks and uncertainty. It is the special functions of the speculators to assume these risks and help to increase production.

• Thirdly, stock exchange speculation performs another social objective. Investment in capital mar­ket is guided by speculation. Since shares can be easily bought and sold, the cause of long-term in­vestment is promoted by the existence of stock markets. Again, if speculators are well informed, the prospects of different classes of industrial es­tablishments will be reflected in the present quota­tions of stock prices.

The ordinary lay investor will thus get a reliable guide in stock market quotations for the proper disposal of his savings. The entre­preneur may also raise fresh capital funds by issu­ing fresh shares through the stock market. Thus stock exchange speculator helps the investor, the manufacturer as well as speculator himself.

Stock Exchange Speculation:

Speculation in shares is an important form of speculation. Security prices change frequently due to the uncertainty of their future yield about which market expectations vary frequently. Security prices also vary owing to the varying liquidity preference of the public. In the stock exchange there are al­ways some speculators who expect that the prices of securities will rise and others who expect that the prices of security will fall.

Those who expect that security prices will rise are known as ‘bulls’ while those who expect that security prices will fall are known as “bears’. If all were bulls and there were no bear’s security prices would go on rising indefi­nitely and there would be no equilibrium level of security prices.

Conversely if all were bears and none was a bull security prices would go on falling down to zero level. But things seldom go on in this way. As prices go on rising, some of those who pre­viously thought prices were too low might be in­duced to revise their expectation? and night be transformed into bears.

Similarly, when prices go on falling, some of those who previously thought that prices were too high might be induced to re­vise their expectations and might be transformed into bulls.

A share market is said to be a bull mar­ket if the bullish sentiment is greater than the bear­ish sentiment and it is said to be a bear market if the bearish sentiment is more powerful than the bullish sentiment. Both bulls and bears are always there in every stock market.

Similar to “futures’ contracts in the commod­ity markets there are dealings in ‘futures’ in the stock market. A speculator in the securities market sells “short’ when he contracts to deliver shares to a buyers at some future date at a price fixed at present. The ‘short seller’ is a bear who expects a fall in the future spot price and who hopes to fulfill his con­tract offer buying shares at the future expected low price.

Just as bears are counter balanced by bulls in the spot market similarly in the futures market the short seller is counter balanced by the “margin buyer’. Margin buying is in effect a contract to de­liver money at a future date in return for shares purchased now. The margin buyer is a bull he ex­pects a future rise in the price of shares and hopes to be able to sell his securities at a profit before the date.

Evils of Speculation:

There are two types of speculation simple or competitive speculation and aggressive or monopo­listic speculation. All the benefits of speculation are the benefits of competitive speculation. But we of­ten come across aggressive or monopolistic specu­lation where rich and powerful persons try to ma­nipulate the market price by their own bulk trans­actions so as to extract profits for themselves.

Such profits constitute a form of tribute which they are able to extort from society. Aggressive speculation does not make for an optimum allocation of re­sources—rather it moves society away from such optimum allocation. Instead of reducing price dif­ferences it aggravates such differences and prevents competitive forces from bringing about an equalisation of prices over time and space.

The remedy for monopolistic speculation is as Prof. Lerner suggests, counter speculation. A Govt. agency may fix up appropriate prices and guarantee them to buyers and sellers and may thus make it impossible for any powerful speculator to manipulate prices. Statutory price fixation backed up by governmental resources alone can save soci­ety from the consequences of the predatory activi­ties of aggressive speculation.

Speculation of the type which is beneficial to society is called legitimate speculation; specu­lation by ill-informed persons and by men who try to rig the market is called illegitimate speculation. Legitimate speculation is beneficial to society and as such requires no control. But illegitimate specu­lation is an evil and as such should be suppressed. The remedies suggested are generally inadequate.

One remedy against illegitimate speculation is the passing of legislation prohibiting such action. But there are loopholes in all legislations. It is for this reason that Prof. Taussig said that the most effec­tive remedy is a better moral standard for all in­dustry and an arousal of public opinion against all kinds of gambling.

According to Lord Keynes stock exchange speculation is responsible for much of the insta­bility of the current economic order. If expert speculators are actually engaged in forecasting the future prospects of a concern, they might confer a great benefit to society. As a matter of fact, few speculators have the intelligence, energy to fore­cast correctly the future prospects of a concern.

The wide fluctuations that often take place in security prices are due to conventional valuation of a large number of ignorant individuals. Keynes has aptly said that speculators may do no harm as bubbles on a steady stream of enterprise.

But the position becomes serious when enterprise becomes the bub­ble on a whirlpool of speculation. When the capi­tal development of country becomes a by-product of the activities of a Casino, the job is likely to be ill-done.

Types of Speculators

The speculators are classified into four categories such as

• Bull
• Bear
• Stag
• Lame Duck

1. Bull: A bull is an optimistic speculator. He expects a rise in the price of the securities in which he deals. Therefore, he enters into purchase transactions with a view to sell them at a profit in the future. If his expectation becomes a reality, he shall get the price difference without actually taking delivery of the securities.
2. Dear: A bear is a pessimistic speculator who expects a sharp fall in the prices of certain securities. He enters into selling contracts in certain securities on a future date. If the price of the security falls as he expects he shall get the price difference.
3. Stag: A stag is considered as a cautious investor when compared to the bulls or bears. He is a speculator who simply applies for fresh shares in new companies with the sole object of selling them at a premium or profit as soon as he gets the shares allotted.
4. Lame Duck: When a bear is unable to meet his commitment immediately, he is said to be struggling like a lame duck.