Speculation, in a financial context, is making an investment that increases the overall risk in a portfolio. The opposite of speculation is hedging, which is making investments that decrease the overall risk in a portfolio. The reason the context of a portfolio is important can be illustrated by example: investing in futures contracts to buy oil is generally considered to be risky and speculative; however, if your portfolio predominantly contains airlines, investing in oil contracts could very well reduce or hedge your risk. (Note that airlines frequently invest in oil futures and hedge their own oil risk, so in the absence of inside information, making such investments could indeed be speculative.)

Investment is the assumption of the risk of loss, in return for the uncertain possibility of a reward. Financial speculation involves the buying, holding, selling, and short-selling of stocks, bonds, commodities, currencies, collectibles, real estate, derivatives, or any valuable financial instrument to profit from fluctuations in its price as opposed to buying it for use or for income via methods such as dividends or interest. Speculation represents one of three market roles in Western financial markets, distinct from hedging and arbitrage.

Speculation areas

Popular convention, and especially satire, sometimes portray speculators comically as speculating in pork bellies (for which there is an active commercial market — as well as a futures market in which real speculators coexist alongside the dominant commercial hedgers active there) and often as "losing their shirts" or making a fortune on small market changes. While speculation does exist in many relatively small commercial markets (as measured by aggregate market value) such as cattle, hogs, pork bellies, orange juice, and lumber, just as it does in the massively more important global markets such as foreign exchange and petroleum, for most such markets, large and small, such risk-transfer instruments as futures contracts and other derivatives are available both to commercial as well as to speculative interests to establish a large position with only a small deposit of capital (i.e., with substantial leverage). That leverage subjects the one without a counterbalancing commercial position (i.e., the speculator) to the risk of an enormous loss in proportion to one's capital on deposit, in return for the sometimes speculative opportunity for an equally enormous reward in response to a fairly small move in the underlying market.

Type of speculators

By some definitions, most long-term investors, even those who buy and hold for decades, may be classified as speculators,Fact: date=February 2007 excepting only the rare few who are not primarily motivated by eventually selling at a good profit. Some dedicated speculators are distinguished by shorter holding times, the use of leverage, by being willing to take short positions as well as long positions (in markets where the distinction can be reasonably made). A degree of speculation exists in a wide range of financial decisions, from the purchase of a house to a bet on a horse; this is what modern market economists call "ubiquitous speculation."Fact: date=June 2008