Forex - the Concept of Speculation

By: Justin Stewart

Speculation is defined in several ways, but where anything financial is concerned it most often relates to business transactions that involve considerable to extreme risk factors. Despite the negativity associate with risk in the financial industry, it has the upside of possibly awarding the investor with large monetary gains. This is especially true in financial arenas such as the stock market, futures, commodities, and of course, the forex market. Generally, the largest group of speculators is comprised of hedge funds and "position traders."

Currency speculation is oftentimes embroiled in controversy due to the fact that negative effects result on a regular basis, specifically with respect to the devaluation of currencies as well as national economies. Conversely, numerous economists argue that speculators perform an important function in the forex market in that they provide an arena for the hedgers who transfer the risk factors involved in investing form the more skeptical individuals to the ready and willing risk-takers. Conversely, there are other economists who claim that this is economic folly that is founded in politics rather than a free market philosophy of economics.

In many countries, currency speculation is often looked upon with suspicion. Traditional investment instruments such as stocks and bonds are perceived to be positive influences that contribute to the growth of the economy by injecting capital. Currency speculation is viewed as a negative activity in that it is likened to gambling that interferes with the growth a nation's economy.

As an example, currency speculation in 1992 forced the Central Bank of Sweden to inflate the country's interest rates to 150% per annum (for a few days) then later, they devalued the krona (Sweden's monetary unit). Another example involved the former Prime Minister of Malaysia, Mahathir Mohamad, in 1997 when he blamed the devaluation of the Malaysian ringgit on currency speculators.

Economist Gregory Millman refers to speculators as nothing more than "vigilantes" who assist in the enforcement of international trade agreements and then anticipate the possible effects of economic laws for the sake of profiteering. In Millman's opinion, an unsustainable financial "bubble" is created for some countries, and can mishandle their national economies. Consequently, speculators in the forex market will be accused of making the inevitable economic collapse happen sooner.

In certain instances, this sudden collapse of the economy is oftentimes preferred over a constant governmental mishandling of the economic environment. The other school of thought regarding the devaluation of the Malaysian ringgit was that Mohamad and other critics of currency speculation were attempting to shift the blame off themselves for being the real reason behind the economy's devastating collapse. This particular event entails opinions to the contrary given the fact that Malaysia recovered rapidly after the government imposed currency controls which countermanded the IMF's wishes.

On a closing note, other negatives with speculation involve a group of critics within the forex community who feel that speculation will often give rise to forex scams. In this end of the financial market, as with others, the most common scam is a trading scheme wherein individual traders are convinced (fraudulently) that they should invest in the forex market because they will gain huge profits.

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