Forex: Speculation

The opposite of hedging is called 'speculation', the act of taking a net asset position ('long position') or a net liability position ('short position') in some asset class, here a foreign currency; that being said, speculating means committing oneself to an uncertain future value of one's net worth in terms of home currency. It can therefore be assumed that anybody who speculates is acting on the basis of something he or she expects about the future price of the foreign currency.

A rich imagery surrounds the term speculator. They are usually portrayed as a class apart from the rest of humanity. In the frequent newspaper imagery, are viewed as being very greedy--- unlike the rest of us, of course. They are also viewed as exceptionally jittery and as adding an element of subversive chaos to the economic system. They come out only in the middle of storms: we do not hear about them unless the economy is veering out of control, and then it is their fault.

Although speculation has indeed played such a sinister role in the past, it is an open empirical question whether it does so frequently. More to the present point, we should recognize that the only concrete way of defining speculation is the broad way just offered. Anybody is a speculator who is willing to take a net position in a foreign currency, whatever his motives or expectations about the future of the exchange rate.

The foreign exchange market provides the same bridge between currencies for speculators as for hedgers, since there is no credentials check that can sort out the two groups in the marketplace.

The profitability in speculating a foreign currency depends on whether or not one expects the value of that currency to drop by as great a percentage, as its interest rate exceeds the domestic interest rate. The existence of a foreign exchange market does not guarantee that speculation will be profitable. It only makes speculation feasible for those willing to take the chance.

It should be clear to anybody with wealth could be speculator. Speculation need not be confined to an elite financial group, though having inside information is of some value on the average, just as it is in a stock market. Ordinary firms engaged in international trade can do and speculate. An exporting firm or an importing can speculate in the course of its ordinary international business, through what are known as leads and lags, in trade payments. There is usually some leeway, often a few month's leeway, in one gets paid for exports, or pays for imports.

If it is generally feared that a certain currency in some country will drop in value soon, say, U.S. importers are likely to press for prompter payment from its foreign customers, who are allowed to repay in such currency.

If the U.S. exports happen to be in dollars, then it is the foreign importer who has an incentive to pay such currency to get dollars now, while each currency still buys more dollars.