speculation: people borrowing money to purchase stock (i.e. shares in companies) in the hope of selling it later and making a profit.
eg Widget company issues stock at $5 / share.
Person wants to buy 10 000 shares. Therefore, cost = $50 000.
Borrow $50 000 from the bank at 8% interest. Put down 10% deposit (i.e. $5000).
Therefore, actual loan = $45 000 with $3600 in interest each year.
Positive Scenario: One year later: stock is worth $8 / share.
Person decides to sell all shares. Therefore, gets $80 000.
$80 000 - $45 000 (loan) - $3600 (interest) = $31 400 (profit)
Negative Scenario: One year later: stock is worth $3 / share + concern that it will go
down further.
Person decides to sell all shares in a panic sell. Therefore, gets $30 000.
$30 000 - $45 000 (loan) - $3600 (interest) = -$18 600 (loss)
Imagine, if many, many speculators incurred these kinds of losses.
This would mean that these people would have less money available to buy consumer goods, or to expand businesses or to start new businesses. This in turn would hurt the economy and contribute to a recession or even a depression as with the New York Stock Market Crash in 1929.
Why do share values go up and down?
There are many factors at work but essentially if a company is doing well in the marketplace (i.e. making a product that people want to buy) people will be willing to pay more in the stock market to buy shares in that company.
eg as Microsoft has grown in its dominance of the computer software industry (i.e. Windows ‘95), the value of its stock has risen considerably.
Share values can similarly fall if initial optimism in a company turns sour.
eg Bre-X mining company: false gold find in Indonesia.
Changing economic conditions affect a company’s performance.
eg if a foreign government puts tariffs on a product that a company is trying to sell in that country that could hurt its future.
Changing weather and climatic conditions can affect companies involved in agriculture, fishing, forestry, etc.