Speculative trading is the trading of futures contracts, without the intention of actually obtaining the underlying commodity. These traders buy or sell futures contracts with the intention of re-selling these contracts before the maturity date. They expect the price of a futures contract to move in their favor, which will grant them a profit when selling these contracts. Speculative trading is however very risky, because there is no guarantee prices will move in their favor. When prices move against their position, this can result in substantial losses. They fulfill a number of roles which are of vital importance to the commodity market.
Liquidity and Efficiency
Speculative traders maintain a liquidity which is vital to the effectiveness of the commodity market. The level of liquidity is determined by the ability of an asset to be sold rapidly and with minimal loss of value. This requires a large amount of sellers and buyers to be active on a market. On the futures market there are numerous traders and thus there is virtually a buyer and seller willing to obtain a futures contract at any moment. It can be very time-consuming for a producer and an end-user to agree on a contract for the delivery of a commodity. There is always a trader willing to buy a contract, because he believes he will be able to sell it at a later date with a profit. Therefore it is easier for producers and end-users to sell their contracts on an exchange, where traders will buy the contracts and then trade these contracts with other traders or an end-user.
Speculative traders are both a liability as well as an essential when considering risks. First off al they reduce the price risks for producers because they are willing to buy a contract at a fixed price. Due to this fixed price, producers are insured of an acceptable price for their product and thus will be motivated to increase their supply. Therefore traders take over the price risks of producers and simultaneously stimulate an increase in supply.
Traders themselves can however also generate additional risks. Because of their speculative trading they will sometimes rise prices in such a manner that they are no longer in accordance with the underlying asset. In such a situation this so-called economic bubble will eventually burst and result in a rapid decrease of the price.