Reprint from The Pitfalls of Speculation by Thomas Gibson 1906 Ed.
THE PUBLIC ATTITUDE TOWARD SPECULATION
THE public attitude toward speculation is generally hostile. Even those who venture frequently are prone to speak discouragingly of speculative possibilities, and to point warningly to the fact that an overwhelming majority of speculative commitments result in loss, while those who venture not at all, and consequently are incompetent to judge, dismiss the subject with the statement that marginal trading is gambling, pure and simple, and is therefore pernicious.
Those who enter into the subject a little farther, and attempt to adduce more specific argument against speculative possibilities, lay stress upon the statement that manipulation, trickery and wholesale deception render it impossible for the outsider to enter the field safely or intelligently. These statements, usually unsupported, and frequently insupportable, are accepted by the prejudiced multitude as gospel truth, without any attempt being made to examine their foundation or correctness.
So far as the question of gambling is concerned, it would be entering a very large field to attempt to define just what is and what is not gambling.
The idea that the man who buys a certain stock outright invests, while he who buys on margin gambles, is a popular fallacy. The speculator purchases in the hope of an advance, and if two purchases are made for parallel reasons, one for cash, and one on margins, both purchases are speculative.
That speculative fluctuations are largely used as a basis for gambling operations, is unquestionably true, and possibly an acceptable dividing line may be drawn on the following hypothesis: gambling, in the general acceptance of the term, is founded upon blind chance, the equal possibility of certain events occurring or not occurring; this is modified in some cases by the exercise of superior skill in such games as admit of skill; but fundamentally, gambling is wholly dependent upon the equal chances of two or more opposed individuals.
The trader, therefore, who takes “flyers” with no knowledge of his subject or the properties in which he deals merely gambles on the ultimate rise and fall of the market; but the trader who after careful investigation and study purchases a property either outright or on margins because he has reasons for believing it to be cheap and that it will enhance in value is a speculator.
Those composing the gambling element are in the majority and it is, needless to say are the greatest losers; in fact their losses foot up almost the sum total of speculative deficiency and consequently the sum total of the gains reaped by the real speculator.
The statement that most public commitments are made on no better foundation than a mere guess may seem a trifle bold and the counter statement may be made that few people purchase a stock without some reason for so doing. This is admitted on the same basis that the man who bets on a certain number at roulette because it has not recently appeared or in hope of an immediate repetition considers that he has a reason for his action. Thus a great number of amateur or semiprofessional traders buy a certain commodity for no better reason than that the stock has declined or more frequently from a participation in a period of speculative intoxication. They can give reasons for their ventures, but they are without foundation, and are no more worthy of consideration than the reasons given by the roulette player for “staking” upon a certain number.
On the other hand, the speculator, with a carefully acquired knowledge of the normal value of certain properties, fully posted on conditions in general, and those affecting, or liable to affect his favorite property in particular, patiently waits the opportunity to buy, not at a normal price, but at a price far below the actual value of his property. He knows that speculative prices move in cycles, more or less pronounced and prolonged, and in the revolution of this cycle he will be given an opportunity not only to purchase at a price far below a normal valuation, but to sell at a price far above it.
This looks simple enough in the telling, and is merely the operation of Anselm Rothschild’s famous advice, “buy cheap and sell dear.” But when the statement is made that over 90% of public purchases are made at the approximate high tide of a market and about the same percentage of sales at the approximate low tide, in short, that the most simple and reasonable methods of making money are not only disregarded, but actually reversed, a great field for analysis and discussion presents itself.
Manipulation and trickery are vastly overestimated: popular prejudice continually accords to such causes events which were brought about almost wholly by the composite folly of public participators in speculative affairs, and which could not possibly have been effected by any individual interests.
That these stages of undue depression and inflation are to some extent assisted by the shrewd minority is true; but the great work is that of the public itself.
That the money-making minorities foresee, and take advantage of these extremes, is unquestionable. They are the cause of all speculative movements of importance, and through the errors and losses of the lambs the accumulations of successful operators are made possible.
After a careful examination, covering a period of ten years, and a study of the methods of successful and unsuccessful traders as shown in some thousands of speculative accounts, the following facts are adduced:
1st – The greatest causes of loss in speculation are ignorance, over-speculation, and carelessness, of importance in the order named.
2nd – The popular fallacy that business methods are not applicable to speculation is wholly erroneous.
3rd – Not one speculator in a thousand applies ordinary business precautions to his trades, nor founds his ventures upon knowledge of any value.
4th – The correct trader has little to fear, and much to gain from manipulative tactics.
5th – While extremes of prices move in irregular cycles, no “system” for judging changes is possible, or tenable, as such mechanical attempts to forecast price changes do not contemplate changed conditions, or provide for accident. The advocates of the “Chart System” are legion, and yet it is impossible to find a single permanent and substantial gain made by this method.
6th – The general idea that the actual value, and probable future of a property cannot be intelligently based, is erroneous.
7th – The greatest speculative profits are made in stocks, and the greatest speculative losses, in staples: wheat, corn, cotton, etc.
8th – There are certain technical stages, or conditions of markets which are followed by certain invariable results, the study and recognition of which is valuable, and not difficult. These “ear-marks” are in some cases very plain, and do not in any way smack of the “systems” deprecated above, but are more or less visible signs of effects following certain causes.
9th -Almost every general idea of speculation is the exact reverse of the truth. Sometimes this is caused by false reasoning, but most frequently by the innate false appearance of the market quotations. For example, greatest activity and interest in a market occurs around top prices; while dullness and stagnation are invariable when properties are unreasonably low in price.
10th – Persistent short selling of stocks is fashionable in a certain class of semi-professional traders, and almost invariably results in loss.
11th – Tips are illogical. Any wide-spread dissemination of advance information as to a projected movement would defeat its own object. The so-called “tip'” is usually mere guess work. The general consensus of public opinion on this subject is correct, i. e., tips are valueless; and yet the public continues to use them largely as a basis of trading.
12th – Too great facilities for obtaining information and executing orders, is, to the ordinary trader, of no advantage, and is frequently a source of loss. (The accounts mentioned above show the most intelligent trading to have been done by traders who were without facilities to interfere with their own original plans through fright or confusion.)
13th – Speculation is a safe business when business methods are applied to it. The changes in prices of standard properties offer yearly greater opportunities for profit than any other field. That is to say, for reasonable profits, not for the amassing of fortunes on small capital, in a brief period, but for steady accumulation of money and valuable knowledge. So great are the opportunities offered by speculative changes that with proper methods and self-control, the poor man cannot afford to overlook them.
To make these rather radical statements ill a general way is wholly insufficient; each statement must be supported by the presentation of convincing precedent and clear reasoning, and it is the purpose of these articles to point out the reasons for the failure of the majority, as well as the methods by which the minority succeed. This done, the knowledge so gained must be insulated into useful channels, and combined into flexible rules, and inflexible laws.
It is not claimed that it is possible to set down in print a formula for speculative success: much depends upon the individual. A man is not a machine, and will be frequently swerved into paths which he, himself, knows to be dangerous, and an individual incapable of clear thinking and correct application of accrued knowledge, would not succeed at this, or any other business.
The most that may be hoped for, consequently, is to point out certain facts which will lead to a correct line of thinking, or open the way to profitable discussion. To this end, the various causes of loss mentioned will be discussed in turn.
IGNORANCE, OVER-SPECULATION, ETC.
IGNORANCE, over-speculation, and the innate false appearance of market stages are the principal causes of speculative loss, and are, in truth, the principal causes of the great cycles of speculative extremes. These extremes are variously attributed to specific causes, affecting certain securities, to good or bad business conditions, or to accident or manipulation; but the fact of the matter is that the wide swings of the market are brought about almost wholly by the errors and ignorance of the great body of traders known as the public.
Conditions change, accidents occur, and manipulation exists, and all have their effect; but unless these factors were supplemented by alternate waves of general over-confidence, and subsequent undue depression, the fluctuations in market quotations for standard properties would be confined to such narrow limits that the repeated opportunities to purchase such properties at prices far below, and to sell them at prices far above a normal value, would be eliminated.
Almost all the commitments made by public traders are made on faith, or on misleading surface appearances. The advice of people absolutely incapable of passing intelligent opinions, is eagerly listened to and frequently acted upon; large dividends on low-priced stocks are made the basis of optimistic views and shallow arguments; the fact that a certain stock has dragged back in a generally strong market,—usually the best evidence in the world of something radically wrong with that particular stock,—incites what may be very undesirable purchases. The development of certain long-heralded events, such as the payment, or increase of a dividend, is considered a good reason for the purchase of the security affected, when in fact it is no reason at all, as Wall Street always anticipates and discounts probable good news. These and a hundred and one other reasons, mostly ill-founded, are the groundwork of the great bulk of public ventures, and the individuals who operate on these unreliable signs, with full knowledge of the fact that the public has been misled by them time and again, seldom attempt to investigate the intrinsic value of the property in which they have assumed and paid cash for a proprietary interest. Such an investigation is usually considered useless or impossible. If this were true any participation whatever in speculative affairs would be folly, but fortunately this common opinion is itself the result of ignorance.
Over-speculation, the composite result of ignorance, greed, and false appearances, may be classed as the primary cause of wide variations in prices, for as much too high as a market is carried by rash participation at high prices, just as much too low will it sink in the ensuing decline. The ill-advised traders who rush in at high prices with inadequate capital are the first to suffer; their overthrow topples over other weak accounts, and so on down the line, until the last of the wobbly row of bricks has fallen.
It might be contended that when this process of elimination had brought prices of good properties to a fair valuation, purchasers would be easily found, and such might be the case, were it not for the fact that the great lights of speculative finance know full well that the technical position of the market is still bad; that many venturers, already financially weakened by the decline from abnormal to normal prices, are in a position which they can be forced to abandon; that the pendulum of prices Will swing to the other extreme, and they refrain from buying at normal prices for the good and simple reason that they know they can eventually buy at prices that are very low. Perhaps these low prices will come about unaided, through the internal rottenness of the technical situation; perhaps the desirable consummation will require a little assistance, such as the passing of a dividend or two, the closing of a few mills or the laying off of a few men, all of which actions can in the future be pointed out as good and conservative business moves, but which will be received by the public with anger and disgust; for so dense is general ignorance on this one subject that the payment of a dividend is always considered good, and the reduction or passing of a dividend is always considered bad; a bond issue, for whatever purpose, is an unmixed evil, and so following.
The professional bear element also assists in the final downfall of prices. They will be well aware of the assailable condition of the weakened long interest, and will attack the market for the purpose of reaching stop-loss orders or forcing crippled speculators to sell. These same bears may later be hoist with their own petard, for a chronic bear is a chronic loser, but meanwhile they assist the successful campaigners materially by forcing a temporarily lower level of prices and supplanting weak long accounts with a short interest, which is in itself a great advantage to the bull element.
So familiar is the experienced speculator with public weakness that he is usually found operating in direct reversion to prevailing sentiment. He knows by careful and clear-headed investigation the normal value of the property or properties in which he trades, and at such time as he finds the current quotations far below this fixed point and the public inveighing bitterly against his favorite issues, he begins his purchases. It does not require much shrewdness to deduce, the fact that if a certain standard security has passed out of public, or weak hands, it has of necessity been concentrated in the strong hands of the giants of finance, and that the purchaser at such periods is at least in good company. He has no fear of any abnormal shrinkage in the value of his holdings, as such sudden shrinkages are the result of panic or financial necessity, to which the present holders are not subject. He also knows that any manipulation must now be for the purpose of creating higher prices as the next great speculative move will be to resell the cheaply purchased properties at high prices and the public being absent there is no one to manipulate against. He is certain that unless all precedents fail he will at some future time see high prices and general good feeling supplant the present depression.
As has been stated the innate false appearance of speculative surroundings does much to influence public participation at the wrong period. When stocks are low in price the brokerage offices are deserted, the newspapers say little of speculative affairs, transactions are limited, and those who have been worsted in the preceding decline speak in pessimistic terms of the future. A long period of dullness almost invariably follows a severe decline. New lambs must be born and the old ones suffered to grow a new fleece and dullness is always unattractive. But at the crest of a great movement all is activity. Excited groups gather about the tickers and predict future events founded principally on illusions or hope, and stories of quickly acquired gains are heard on every hand. A fever of speculation fills the air and men who had no thought of venturing during the time of depression and low prices, now purchase anything and everything at prices that are very high.
The mistakes discussed above—ignorance; the belief that speculative riches are the result of luck rather than of judgment, over-speculation and misleading surface appearances, combine to make it possible for the shrewd and successful minority to buy and sell periodically to great advantage by an almost exact reversal of public methods and beliefs. Their operations are not founded on such reversion, but on study and knowledge of past precedent, present conditions and future probabilities. The fact that public opinion is diametrically opposed to
their views may be cheerfully considered as excellent proof of the correctness of their deductions, as the public is usually wrong.
If the statements made above are admitted to be correct the lesson they teach is obvious. To result successfully, speculative ventures must be based on sound reasoning and a knowledge of correct normal values; on a willingness to confine operations to reasonable limits and upon emancipation from the moving influences of general exhilaration or depression. The individual who begins or pursues his operations on these great fundamental principles has taken a great step toward the goal of success.
Reprint from The Pitfalls of Speculation by Thomas Gibson 1906 Ed.