Why is speculation important to our economy?

A lot has been said recently about speculators. Wall Street is often blamed for our current economic issues. What we fail to recognize is that the speculators provide a very important role for our society. If money makes our world go ’round, it is speculators that make money go round. The purpose of this article is to share with you the importance of speculators and to share that some of their practices, which are frowned upon, actually play a necessary role.

Speculators provide liquidity to our world. Liquidity is the availability of cash, a liquid asset, to a market. If speculators with large amounts of money did not “make a market” to buy and sell with, market charts would be straight lines.  If it were not for liquidity it would be very difficult to buy and sell products- there must be someone on the other end of your transaction.  Without liquidity, it is a five foot wide car and a five foot wide bridge trying to cross a river. There would be no room for maneuvering. 

Doing this is not easy at all. It can be similar to stepping in front of a freight train. Going back to the example of car crossing river, not only do speculators widen the bridge by providing liquidity, they also act as the road blocks to keep everyone on the bridge.

When the market is falling hard, it is the speculators that save the day by buying at the bottoms. It is similar to catching falling knives.  When the market has gone higher than the true value. they are the ones that step in and sell at the top. Essentially, what they do is keep the market honest. They ensure that the markets are not manipulated artificially high or low values. Without these people stepping in, someone up to no good could manipulate the market. They could easily run the market up or down at will, destabilizing our economy.

One thing a lot of people forget, in light of what we see as their success, is that most that try to be speculators will fail. 90 percent of those who attempt it will lose all their money and be left finding something else to do. It is simply not in everybody’s scope to be a professional speculator.

Often one practice that is frowned upon is short-selling, or selling short the market. The simplest way to describe it is that person A sells shares of company ABC, without owning it, to person B. Person A sells these, believing that the market has gone too high. Person B buys the shares, believing that the rate will go higher than what it is, or to cover a short.

It seems like a terrible thing to do, selling someone short, but the truth is that the speculator selling short just provided the other end of the trade for person B. Assuming that Person A was correct, the price of the shares go lower. At the point when person A believes that price has gone down far enough, they will buy to cover. This means that they will need to buy what they sold (without owning it) at a higher price, in order to return the product. They have joined all the buyers, acting as a road block, to step in front of a freight train and end all the selling pressure.

This practice is very important to the market. What it does is provide stability to the market. If everyone kept buying, the market would go straight up. Once they started selling, the market would go straight down, but having people buy when the market goes down and having people sell as the market goes up reduces the volatility that would have existed in the market without short sellers.

We must remember that the service these people provide is very important to our society. Few have the talent or account size to be able to perform the same duties. Their practices are good for our economy. There is simply no reason to be angry at speculators.