In defence of the speculator

Governments, regulators and the financially illiterate across the world, suspect, fear and abhor speculators. ‘‘They manipulate ma...

Governments, regulators and the financially illiterate across the world, suspect, fear and abhor speculators. ‘‘They manipulate markets, they are here to make money — imagine that! — and leave you with junk, they are a threat to ‘gullible’ small investors, who don’t have enough information and run after stocks after they’ve been amassed by these villains, who sell them at a huge profit.’’ I just can’t understand why thousands of people, pursuing a full-fledged, legally-sound profession, are being looked at as morally depraved bad-guys.

Here’s a regular man-next-door, with a family to support, who has chosen to buy and sell stocks for a living. He has invested his capital to buy and sell these shares. He has invested his time and mind in studying price movements, maybe even fundamentals of companies. He has made efforts to come to grips with the entrails of how trading works. And he’s there to make a profit out of it.

Quite like the rest of us, who invest time and mind studying to be pilots, engineers, policymakers; hone our skills at marketing, finance, product development; stay on top of changes in our company, sector, industry (and now even countries) that could affect our income and wealth. It’s a job we do and so does the speculator.

Just what does a speculator do? He trades — buys and sells in short time-gaps — stocks, currencies, commodities, derivatives and even real estate. He does this by taking a call on where prices will be in the short term. The term could be as short as a couple of days, it could be a couple of weeks, or even a couple of months. Much of his investment is leveraged, that is, he invests on margin. He takes extreme high risk with his investment — if his call is wrong, he generally loses all his money, if right, he gets a fat return.

Above all, he serves a very important function in society in general and in the stock markets in particular. But for him, there would be no liquidity in the market. Meaning, if an investor wanted to sell his shares at any given point, she would spend far more time seeking a buyer who would pay the price she’s asking for, or else, sell at a lower price and increase the spread between the ‘buy’ and ‘sell’ price of a share. The speculator, by absorbing a significant part of market risk (the potential to lose money), in lieu of significant rewards, smoothens transactions.

This ‘value’ is not seen to be value. Critics say that it is an Infosys that organises people, resources and markets to produce software that produces value for its customers and the economy, and speculators simply come in and cream off undeserved profits. That argument is partially true — yes, the speculator doesn’t make software, add value. But the value he provides allows thousands of Infosys employees and shareholders to encash their wealth, when they want it, at the least cost.

Let’s take two shares trading more or less in the same price range, State Bank of India (SBI) and 3M. Both are good companies, with good track records. But the buy-sell difference in the case of 3M is Rs 15 or 2 per cent. The same difference for SBI is just Rs 4.50 or 0.6 per cent. So, when you buy 100 shares of a relatively illiquid 3M (average number of shares transacted: 636), you end up paying Rs 1,050 extra over a liquid SBI (number of shares transacted: 19.7 lakh).

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Similar are the differences between an ITC (price: Rs 1,697, volume: 1.8 lakh shares, turnover: Rs 30 crore) and a Monsanto (Rs 1,630, 418, Rs 6.8 lakh); between a Siemens (Rs 2,283, 89,000, Rs 19.9 crore) and a State Bank of Travancore (Rs 2,175, 360, Rs 7.8 lakh); between a Bharat Electronics (Rs 703, 50,059, Rs 3.5 crore) and a Revathi Equipment (Rs 725, 845, Rs 6 lakh). And so on.

That’s not all. Often, the same company may quote at different prices on two exchanges — in India, the BSE and the NSE. Here, a trader sits with the two screens, buys on the exchange that offers him a lower quote and sells in the other one for a profit. Technically, this is called arbitrage. And this too serves a function — that of equalising prices.

Unlike fifteen years ago, the potential for manipulation in the top 100 or even 200 shares is difficult. That’s why the buy-sell difference in these shares is small. Compare that difference with smaller or less traded stocks, and you’ll know the role of the speculator and the value he brings.