Futures Trading 101: What Is A Speculator?

So what does it mean exactly to speculate? First there was, John Maynard Keynes speculating as a currency trader in the 1920’s where experience taught him, “The market can stay irrational longer than you can be solvent.” Then there was the hyperbolic oil market of 2008 where the NYMEX weekly close went from $97.91 in January to $145.29 by July 4th! Then, there’s futures trading where a career can be made by taking the other side of a hedger’s trade. But who are these people? For all of you chimps out there, check out this infographic from the CME Group on who exactly speculators are...



SPECULATE: To engage in the buying or selling of a commodity with an element of risk on the chance of profit.



PURPOSE
A wheat farmer [see Futures 101: What Does Hedging Mean?] can’t hedge their crop unless someone assumes their risk and the speculator is that risk taker. Either by gut instinct, research, or word-of-mouth they act on information which leads them to believe a profit opportunity exists. Think of it as a voting mechanism with money for the most established market opinions. The more money in a particular position for a particular commodity, the stronger the consensus and conveying a signal of what to expect in the future.


PROFIT
Speculators can profit by purchasing a contract at a set price and then sell it at higher future spot prices as in the case of a drought. Conversely, they can also short the contract because future spot prices are expected to fall as in the case of a bumper crop.

However, speculators aren’t just futures traders. They can be homeowners looking to “flip” houses, index fund investors looking towards retirement, or a small business trying to sell itself but they all have one characteristic. They’re looking to purchase an asset with the expectation to sell it for a profit in the future and with the future comes the risk of loss.


speculators infographic

CME Group - Ensuring Effective Market Place




PLAYERS
Here are some famous speculators and their calls:

- bet at “bucket shops”, BOS banned his trading, amassed & lost fortunes multiple times
George Soros - “broke” the BoE by shorting the £ and scoring $1B+ in a single day
- "The Lone Wolf on WS", speculated in the sugar market, purchased a NYSE seat, and the City College of NYC was named in his honor


Questions, comments, or concerns? Put it below.

 
Best Response

I agree and disagree. Per good ol' Benny Graham....

In their 1934 classic text, Security Analysis, Benjamin Graham and David Dodd provided a general definition of speculation: "An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative."


However, by the definition above....

SPECULATE: To engage in the buying or selling of a commodity with an element of risk on the chance of profit.



...then only arbitrage would NOT be speculation (by definition). When George Soros shorted the pound, he saw an insane opportunity that everyone else was too prideful (among other reasons) to see. There was so little risk in Soros's "breaking the Bank of England" that it's ridiculous. What occurred would have happened no matter what; he just positioned himself in such a way that the people of England were literally paying him a billion. Speculation is an investment made where there is little to no analysis, and little reassurance of return of capital. Sure this post is titled "Futures Trading 101", but the difference between investment and speculation is an important one.

Maximum effort.
 

Two slightly off topic observations:

1) Jesse Livermore is a character, wonder how he blew through $100MM. He and his descendants were a little screwy.

2) I really like the instructional materials on CME's website.

 

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