Reigning in Speculation

By October 20, 2014 Trading No Comments
Reigning in Speculation

Who are speculators?

A speculator is a trader who approaches the financial markets with the intention to make a profit by buying low and selling high, not necessarily in that order. A speculator is not really interested in ownership or hedging of assets but tries to predict the ups and downs of the market and is interested in price action. A speculator can be an individual, a bank or any other institution. The biggest speculators are hedge funds who now operate with more than $2 trillion globally.

Reigning in speculation in share market

Speculator

What role do they perform in the markets?

They act as liquidity providers in the market and often act as a counterparty to individual and institutional investors. Without their participation, volumes would be lower and investor will run the risk of higher impact cost on their trades and arguably higher volatility as well. On the contrary, strong speculative forces can result in mispricing in markets and can result in unwarranted losses for investors and hedgers.

How do they operate in markets?

Speculators can approach markets in different ways, they can play arbitrage between cash and derivatives segments, between same instruments on different exchanges, can bet on events like stock splits, IPOs, earnings, rights issues and/or special situations like mergers and acquisitions, open offers, management rejigs etc. They can also make bets on macro-events like interest-rate changes, central bank or government policy changes, changes in tax structure or import/export duty changes. Their ways to operate might differ, but aim is always to use price movements to reap profits.

Speculators, Investors, Gamblers

Whether they succeed?              

Speculators like investors run risks and can lose or make money. Typically speculators prosper in volatile and heavy news flow driven markets.

Reigning in speculation

It is very important for regulators like RBI and SEBI to keep a close watch on activities of speculators so that their role is restricted to liquidity providers and their actions do not result in unwarranted volatility and market mispricing. RBI and SEBI constantly manage the risk limits and disclosures of speculators and ensure that their activities are monitored and within legal frameworks.

Examples from recent past

Speculative interest was high in oil in 2007-08 when it crossed $140/barrel in international markets and then crashed to $35 in the next one year. Such kind of volatile moves in a heavily traded international commodity was a clear sign of strong speculative forces. In Indian markets, there have been many periods where speculative interests become high. Last year in 2013, amidst concerns of retracement from quantitative easing by US central bank, rupee depreciated to all-time  low of 68.8/dollar. It has got back to trade around levels of 60 since then. It was a period where speculative forces had to be managed in emerging markets. RBI under new governor came in with steps to curb proprietary trading and banks were only allowed to place trades on behalf of their clients. Globally also Volcker rule and Dodd-Frank Act came through to curb speculation from banks and other institutions after the 2008 financial crisis.

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