In trading, much like in life, traders will make a lot of speculations regarding the outcome of a trade. In fact, this is so prominent that speculating is considered a form of trading in certain financial markets, whereby traders rely upon their intuition and of course detailed analysis to speculate whether there will be a volatility in prices that could end in a positive result for them.
The forex market is a well known speculative market. So to find out more about the notion of speculation itself and the role of speculating in various markets including the foreign exchange market, read along this article.
What Is the Definition of Speculating?
Speculative trading is a form of trading that carries with itself a serious chance of sustaining losses. But at the same time, in this form of trading the odds of profiting can also be high.
The main objective in speculative trading is that traders rely on volatilities in the market. They hope that the volatilities that will take place will result in a positive outcome for their trade.
So speculative traders will highly rely on monitoring the market for any changes, even small and slight changes that can occur and potentially change price movements.
One significant form of speculating in financial markets can be seen in the forex market. In this market traders do not simply purchase a currency and then sell it for a profit. It doesn’t work like that.
The way this market works through speculative trading is that traders make speculations based on currency pairs. They speculate whether the value of two currencies against one another will appreciate or depreciate.
For example, in the trading pair of gold and the US dollar which is shown as XAU/USD you do not actually make gold or dollar for that matter. What you are doing is making speculations on the value of gold denominated by the US dollar.
If your speculations turn out correct, whether you are going long or short, then your position will end in profits. However, if you have not made the correct speculations, then you will sustain losses.
How Do Traders Speculate?
To find out exactly how speculative traders open and close their position and, more precisely, how speculation works at all, let’s compare it with another basic form of participation in any financial market – i.e. investment.
Speculation and investment are ordinarily considered the two sides of the spectrum of partaking in a financial market. But what exactly is the difference between them? Let’s clarify that with an example.
Imagine you buy real estate. And then you rent out the real estate and begin earning a monthly sum, which may or may not be substantial. But more importantly you are now the owner of a piece of property that could appreciate in price in the future. This would be considered investment. It is rather similar to position trading in the forex market. Where you open up a position and then hold on to it for a very long time. This time period can last even months or longer.
On the other hand, if you purchase a number of properties to sell off in the near future, maybe even instantly, hoping that the price difference between what you bought the property for and what you will eventually sell them for, will result in a significant profit. This is an example of how speculation works.
But another aspect of how speculation works is that there is always a chance for profits. This means there is guarantee that prices will exhibit a certain degree of volatility in the short, medium, and also long term. This is especially true in the forex market with volatilities occurring even in the very short term, allowing traders to speculate on the bid ask difference of a given foreign currency pair.
With that segue, let’s move into the role of speculation in the foreign exchange market.
The Role of Speculation in the Forex Market
The foreign exchange market boasts itself of being the largest financial market in the world with respect to the amount of money being traded and invested in this market.
The majority of what traders do in this market is to speculate on the spot prices of foreign currency pairs. So the role of speculative trading cannot be underestimated in the forex market.
This speculation is assisted to yield better results with the help of various forms of analysis, including fundamental and technical analysis.
One thing that ought to be contrasted with speculation in the forex market is hedging. Though they are very similar to one another, there is an absolutely crucial difference between them.
We already elaborated on the concept of speculating. But hedging is something that only mimics speculating. Hedging is a process of buying or selling, usually large sums of assets, merely because you want to protect other positions that you have in the market.
This is what’s mainly carried out by large participants in the market, which includes hedge funds and financial institutions that want to protect their other assets in the market.
Speculating in Other Financial Markets
The forex market is not the only market where speculation is implemented. Many other financial markets incorporate this form of trading.
One such market is the global bonds market. Though smaller than forex, the bonds market is still a vastly huge market. While many might believe that this is a sturdy and strong market, since bonds are almost always backed by various assets, the reality is something else.
This is also true about bonds that are issued by the various governments. Those are thought to be the most powerful bonds. Similar to what people thought about subprime mortgage bonds which were heavily backed. Or it seemed so.
The reality is that bonds are also at the mercy of various factors, including economic indicators, important news events, etc., and these factors could heavily influence the value of bonds. And that is the way through which bonds are traded with the help of speculating.
Another commonplace market where we can see the presence of speculating is the good ole stock market. Speculation happens on a daily basis in this market with countless traders buying and selling stocks quickly and only in the short term hoping that the difference in prices caused by fluctuations in the market would result in profits.
Speculating or speculative trading is a form of trading in which the trader will make speculations as to whether fluctuations in price would or would not take place. As such, given the nature of this form of trading, it can result in significant losses, but at the same time it can be very profitable.
Speculative trading should be carried out by traders who have enough knowledge and experience of the market and know what factors to consider when they are making speculations.