By John Lothian
As I was listening to one of the High Frequency Trading subcommittee reports at the Technology Advisory Committee Meeting of the Commodity Futures Trading Commission a week ago, I took umbrage at some of the language being used to describe trading.
Specifically, I mentioned that I abhor the use of the words “bet” or “betting” to describe what a speculator does. My words startled one of the subcommittee members who was delivering the report.
I said, there is a difference between betting and speculating. I then gave my definition of each. Betting is the creation of risk where there was none before. Speculation is the assumption of risk that previously existed. I gave the example of saying “I bet I can run faster than you” to explain betting.
A speculator speculates. They assume risk in a market that another participant does not want to hold any longer. Long hedgers need speculators willing to be short. Short hedgers need speculators willing to be long. Other speculators need other speculators to give them the liquidity to change their minds about the market direction. All of this is assumption of risk for a contract with a viable economic purpose where some participants have an economic interest in the underlying instrument or commodity and the speculators have a view of the value of the same.
Thursday morning I ran across a story on Huffington Post about how Republicans are not giving President Obama credit for recently lower gas prices after giving him the blame when prices were previously higher. Embedded in that story was a video interview with CFTC Commissioner Bart Chilton.
Mr. Chilton was asked to explain how the futures markets work. Mr. Chilton repeatedly used the words “bet” and “betting” to describe various aspects of trading, including one sentence where he used the words speculators and bets in the same sentence.
I found Mr. Chilton’s interview very disconcerting. He does not seem to like traders who have a very short term view of the markets (high frequency traders) or a long term view of the markets (i.e. index funds or in his words “massive-passives”).
In one breath he was explaining that massive-passives are price insensitive and in another sentence he was saying they were bailing on commodities in 2008 after prices plunged. What he is missing is time frame and context. Index investors are price insensitive to individual movements of markets by are sensitive to the movements of the overall index from a long term standpoint.
He railed against the “Wall Street Premium” in oil prices without giving any explanation or thought to why it might exist and what value it might have in spurring exploration or new energy technologies. He is looking out for the little guy he said.
I have been over some of this before here about Mr. Chilton. However, the issue of using the language of betting to describe the markets at the highest levels of our industry bothers me.
As a broker, I have had customers that were gamblers in their approach to the markets. They were lousy traders. There are some traders who are good gamblers, but their underlying skills are in mathematics, statistics and game theory. These three skills can be applied to both gambling and trading.
While there are all kinds of ways to approach decision making in the markets, from gambling to throwing darts, from fundamental analysis to technical analysis, from behavioural finance to watching the other guy sweat, that does not change the underlying economic purpose of the underlying transaction. One is either a hedger or a speculator. One is either hedging a risk they already have or assuming a risk from someone else. Speculators do not create risk, they assume it.
Speculators in the futures markets provide liquidity and participate with their views in the price discovery process. In that role, speculators can and do move markets. Speculators speculate, they don’t bet.