What it is:
A speculator is a person or an entity that trades securities essentially as bets that the price will go up or down, and as such, typically has an above-average risk tolerance.
How it works (Example):
Although one can argue that all investment is speculation, an acknowledged speculator will buy or sell a security solely to reap a typically short-term profit from the price movement of that security. This motivation differs significantly from those of more traditional investors or hedgers.
For example, consider the purchase of corn futures. A hedger may purchase these securities in order to offset any negative movements in the price of corn and thus stabilize his or her portfolio (these people might be corn growers or cereal companies, for instance). A speculator, however, may buy the very same security simply because he or she has reason to believe the position will increase in value. He or she simply bets on which way the market is going to go.
Why it Matters:
Speculation can sometimes drive securities prices away from their intrinsic value, either becoming overpriced during a buying frenzy or becoming underpriced during a huge sell-off. Although speculators sometimes get a bad rap in the press for this reason, they are a crucial lubricant to the markets, particularly the commodities markets. Although they don't want to physically possess any of the commodities they're trading (that is, they don't really want a truckload of rice delivered to their door), their trading activity brings liquidity to the market, which in turn provides stability and efficiency to those markets.
It is important to note, however, that speculators are generally bigger risk takers than other investors. They are more likely than other investors to use leverage, and as such can suffer huge losses alongside huge gains.