This article will explain the different types of speculators.
What is a Speculator
A speculator is any entity or individual that attempts to make opportunistic profits from changes in the prices of financial instruments over the short term. Speculators can be banks, entities from the corporate and foreign sector as well as individuals from the household sector. These individuals and institutions invest their own or borrowed funds for a short period of time in the capital market instruments, bond, equity, money market, and foreign exchange market. Many people equate speculation to gambling but the two are different. A positive risk premium (a return in excess of government bonds) differentiates gambling from speculation. Speculators take on risk in order to earn a risk premium, but gamblers take on risk even without a risk premium. The probability of profiting from speculation is higher than that of gambling but lower than that of long-term investments. Also, the risk of speculation is higher than that of long-term investments but lower than that of gambling. Unlike gambling, speculation is founded on technical or fundamental research whereas gambling is a game of chance where the probability of loss is high. Speculators actively seek a capital gain or profit opportunities in the financial market. They are key players in the capital market, foreign exchange and the money market. The 4 main types of speculators are a bull, bear, stag and lame duck.
A bull is a type of speculator who anticipates a rise in the price of securities. This type of speculator buys financial securities so that s/he can sell them in the future at a higher price. When the price of securities increases the speculator gains a profit, but when the price falls the speculator loses. A bullish type of speculator in an equity market seeks a capital gain opportunity by purchasing undervalued stocks in order to resell them in the future when their true value is reflected in the market. In the financial market, speculators buy securities with their own funds or use borrowed funds. Bull positions are typical of buy and hold investment strategies where stocks are bought and held onto until the prices change. Also, a bullish position can be referred to as a long position. Bull positions are arguably less risky than bear positions because they require the investor to take limited potential risk in exchange for unlimited potential rewards. If an investor enters into a bull position with a stock worth $10, they loose only $10 if the stock price drops to $0 however, the price can theoretically go up indefinitely.
A Bear is a speculator who anticipates a fall in the price of securities. This type of speculator goes ‘short’. By going short, the speculator borrows securities in order to sell them to an available buyer with the intention of buying them back at a lower price. That way the speculator can benefit from the fall in price of the securities when s/he buys them back to return them to the institution s/he borrowed from. For example, a speculator can anticipate the price of a particular share to fall. If the current price of the share stands at US $1.00 s/he can borrow the shares and sell them at that price. If the price of the share falls to US $0.80 the speculator can buy the shares back at US $0.80 so that s/he can return the share to the lender and enjoy a surplus of US $0.20 from the drop in price.
A stag is a type of speculator that applies for new shares of a company with the view of selling them at a premium after allotment. A stag type of speculator is regarded to be more risk averse than bears or bulls. The word ‘stag’ can also be used to refer to a day trader or speculator who attempts to gain profits from short term price movements of securities. Such speculators make use of technical analysis or tape reading for trading decisions. This kind of stag looks for conditions where the price of a security is likely to have a large price movement. If the price is likely to move upward, the stag will buy securities to sell as soon as the price moves up. if the price of a security is likely to drop the speculator will sell the security in order to buy it back at a lower price. Stags require large sums of money in order to make significant gains from small price movements.
A lame duck is a speculator who is in or near bankruptcy due to bad trades. A lame duck is a type of speculator that suffers multiple losses due to his/her incompetence. The term lame duck is commonly used in Europe. In some cases, a lame duck can be a bear type of speculator who is not able to meet his commitments. Since a bear sells borrowed securities with the intention to buy them at a lower price, a person is said to be struggling like a lame duck when s/he struggles to deliver them to the buyer as a result of them not being available in the market.
Importance of Speculators
The majority of trades that occur on the financial markets are for speculative purposes thus, speculation drives financial markets especially the foreign exchange and capital markets. All types of speculators are essential. Speculation on future currency rates is a major driver of exchange rates and in the capital market, speculators actively seek after capital gain opportunities through undervalued or overvalued securities. Various types of speculators can be found in all kinds of markets and they are useful in increasing turnover and liquidity in these markets. Another reason why all speculators of all types are essential is that they contribute to efficient price discovery. Financial institutions such as banks, hedge funds, retirement funds and securities unit trusts can be speculators. Speculators are also active in the money markets especially in the market for derivatives. Money market derivative instruments such as forwards, futures, options and swaps are mainly for hedging and speculation.