Speculators have been easy scapegoats when markets are in distress or bubbles develop. Financier George  Soros, Washington Democratic Sen. Maria Cantwell and others are pressing for limits on speculative trading and a potential ban on speculation in credit default swap (CDS) markets.

On February 23, the SEC voted to restrict short sales in a company’s stock once it falls 10 percent from its previous day’s closing price. The same day, the CFTC announced it would hold a public meeting on March 25, 2010, to examine futures and options trading in the metals markets. Imposing speculative position limits for crude oil, natural gas, heating oil and gasoline is under consideration.

An  article on Wednesday in the Wall Street Journal, “In Defense of Financial Speculation,” clears up  some misconceptions about speculation. Author Darrell Duffie says some of the uninformed may have confused speculation with market manipulation. He writes:

“Speculators earn a profit by absorbing risk that others don’t want. Without speculators, investors would find it difficult to quickly hedge or sell their positions. Speculators also provide us with information about the fundamental values of investments. When the fundamentals appear favorable, they buy. Otherwise, they sell. If their forecasts are correct, they profit. This causes prices to more accurately forecast an investment’s value, spreading useful information. For example, the clearest evidence that Greece has a serious debt problem was the run-up of the price for buying CDS protection against the country’s default.

Is this sort of speculation wrong? I have not heard why.

Those who call for stamping out speculation may be confused between speculation and market manipulation. Manipulation occurs when investors “attack” a financial market in order to profit by changing the value of an investment. Profitable speculation occurs when investors accurately forecast an investment’s fundamental strength or weakness.”

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