The psychology of speculation

by Henry Howard Harper

SPECULATORS ARE SLAVES OF SENTIMENT

When the whole country becomes pervaded with an epidemic of bullishness the action of speculators is always directed by sentiment rather than judgment; and a market that is swept along by excited emotions is always dangerous,—dangerous to go short of and dangerous to be long of. Hysterical “bulls” care nothing whatever about the earnings or dividend returns on a stock; the only note to which they attune their actions is the optimistic slogan, “It’s going up!” and the higher it goes the more they buy, and the more their ranks are swelled by new recruits. A herd of stampeded cattle (cows no less than bulls) will rush blindly into a river, or butt their brains out against stone walls, trees or other obstructions; they also stampede every critter that happens along their path; and anyone who has ever witnessed a panic in a theater or auditorium, or in the stock market, need not be told that under such circumstances men are but little saner than cattle.

And speaking of sentiment, it is remarkable to what extent the combined business and financial structures of the country are swayed to and fro by this giant motive power. Like the biblical wind that bloweth where it listeth, and man heareth the sound thereof but knoweth not whence it cometh or whither it goeth, sentiment springs up from comparatively trifling or unknown sources and after playing its havoc, vanishes as suddenly and mysteriously as it came. In a bear market a train wreck, or the death of some financier, or an earthquake in Europe, will put the market off to the aggregate extent of hundreds of millions; whereas one of the greatest bull markets in history found its chief impetus in the most universally devastating war the world has ever known.

THERE IS BUT ONE WAY TO BEAT THE STOCK
MARKET; THERE ARE MANY WAYS OF
BEING BEATEN BY IT

It is admitted by the most sagacious financiers that the only sure way of making money trading in the stock market is to get in and out at opportune times, and to stay out most of the time. As against this there are numerous ways of losing money. Among these, one method in particular is quite popular among a class of traders who although too clever and conservative to buy stocks at “top” prices, have not the patience to wait for “bottom” prices. When values begin to crumble after the top has been reached in a bull market there must be a set of “carriers,” or supports, onto which stocks can be dumped on the way down. The market does not collapse like a ten-story card house; it generally goes down gradually for a while, one or two flights at a time, and finds steadying props every now and then which sustain it for brief periods. For instance, a certain stock paying $5 a share annually has been hoisted by degrees from $75 up to $150 a share. When it descends to $140 a few wise traders who have been impatiently waiting for a reaction will buy it because it looks cheap at $140 after having sold at $150; then at $130 another lot of traders who are a little wiser and more patient than the first lot buy it because it looks much cheaper than it did even at $140; and so on down it finds these temporary supports, until at length it gets back to $75, or perhaps lower, where it is accumulated by a few shrewd investors and bargain hunters whose attention has been attracted to the market by front page newspaper headlines announcing that the stock market is in a state of complete prostration. They go on about their business and pay no particular attention to the market until the price has recovered to a point where the stock, returning $5 a share, is no longer “paying its board,” when they sell out at a good profit, and stay out while the speculators carry it on up as far as they like. When the stock was at the bottom price those who bought it on a scale from $140 down were either so overloaded or pessimistic—probably both—that they were unable to buy more and thus reduce their average to a reasonable cost.

THE STOCK EXCHANGE IS A MONUMENT OF
BUSINESS INTEGRITY

It is a popular belief with many people that the stock exchanges are highly prejudicial to the public interest and to public safety; as if they actually manufacture stocks, fix their price, and sell them to the public. It is also believed by many persons—even by men with enough brains to buy and sell securities—that whatever they lose on their transactions is gained by the stock exchange or the broker through whom they trade; and that the brokers on the floor of the exchange plan out each day’s campaign and manipulate the stocks with utter disregard of the outside world. Furthermore, it is commonly supposed by a certain class of uninformed people that stock exchanges create panics and financial depressions; that they are licensed evils, feeding and fattening upon the credulity of an innocent public. Nothing could be farther from the truth; nothing could disclose a more profound ignorance of existent facts than for one to adhere to any or all of these fallacious beliefs. The stock exchange itself has no more control over the price of securities than it has over the ocean tides. It is merely an auction room where anyone may send in orders to sell stocks and bonds, either at a certain asking price, or “at market” to the highest bidder. On the other hand anyone may put in either a limited or “at market” bid for whatever securities he wants, provided they are on the list admitted for trading; and no securities are so admitted without being passed upon by a committee of competent judges whose duty it is thoroughly to investigate every company before admitting its securities to the board. The great value of this service to both traders and investors is plainly evident. The people who run the exchange have no other privileges, prerogatives or authority than to buy and sell securities on their own account, or to act as buying and selling agents for the public, and to execute their orders precisely in accordance with given directions. The interests of the public are safeguarded by every known precautionary device, and if a broker makes a mistake he stands the loss, regardless of what the amount may be. In this connection, those who have stood in the visitors’ gallery of the New York Stock Exchange on a busy day have been induced to wonder how it is possible for the brokers to avoid errors under such seemingly chaotic conditions as exist there. To the onlooker it resembles a riotous mob scene in a modern cinema, and one might easily mistake it for a place where a lot of frantic men are trying to buy insurance on a sinking ship, instead of dealing in gilt edge securities which are not immediately perishable. A benevolent sweet-natured old lady who stood for a time looking down upon this wild confusion was asked what she thought of it. “I think it’s all very interesting,” she said. Then after some reflection she added: “But my husband never told me that we are in a financial panic. And even so, why should the men get so angry with one another?”

No matter what anyone may say or think to the contrary, there is no business or profession on earth in which a higher degree of honor and business integrity prevails than among the brokers on the floor of the New York Stock Exchange; and there is no business or profession in which sharp and unethical practices among its members are more quickly detected, or more promptly and summarily dealt with. And by way of passing comment it may be remarked that the going price of $150,000 for a membership on the New York Stock Exchange would seem to imply that the brokerage business is no less profitable than it is honorable. In its certificates of membership the New York Stock Exchange declares itself to be “An institution whose history dates back to 1792, and whose rules and regulations have been formulated for the purpose of maintaining high standards of honor among its members, and for promoting and inculcating just and equitable principles of trade.” And it is required of every member that in every particular he live up to these principles. It is a place where a nod of the head or a lifted finger consummates transactions involving millions of dollars. In ordinary business affairs a deal wherein only a few dollars are concerned is signed, sealed, witnessed and sworn to before a notary; but here contracts involving millions are ratified by a mere gesture, and never questioned by either party.

Every buyer or seller of stocks is a free agent to do as he pleases, and if he gets hoodwinked through the stock exchange it is generally because in trying to outwit or undo somebody else he overreaches himself and falls into his own snare. The only percentage against him is what he pays in commissions and taxes on his trades; and the only chances against him are his own blunders in judgment; these, indeed, are likely to prove a sufficient handicap. Every corporation whose securities are listed on the stock exchange is obliged to make a full and comprehensive report to the exchange at least once a year, and these reports can be found in any brokerage office; they are always open to public inspection, and no one need buy any stock or bond without first satisfying himself regarding the nature of the industry, capitalization, earnings, management and other details. Moreover, if at any time a purchaser becomes dissatisfied with his investment and wishes to get his money back or change into something else, there is always a ready market for the stock. It may be more, or it may be less, than he paid for it, but in either case it can be quickly converted into cash.

The investor in stock market securities may equip himself, free of cost, with full information concerning every listed security; what the company’s earnings have been over a period of years, how much stock and how many bonds are outstanding, the highest and lowest prices at which the stock has ever sold, and all such matters in the fullest detail. He therefore enters “the game,” as the stock market is oftentimes called, with his eyes open, and the cards all faced up on the table. But if he deviates from sound principles and resorts to dabbling in stocks that he knows nothing about, except from hearsay among traders and market tipsters, and undertakes to guess the maneuvers of cliques who are manipulating them, he has no one to blame but himself for indulging in such an expensive folly.

BOOKS TEACH WISDOM, BUT EXPERIENCE IS A
MORE PRACTICAL INSTRUCTOR

It may be set down as an axiomatic truth that no one can learn the art of making money in the stock market by reading statistics, charts, precedents, theoretical disquisitions and instructions. Of course it is not needful, nor would it be any more practicable than it is necessary, to set forth any fixed rules or maxims governing one’s procedure in any other line of business or any other profession, since no one could use them advantageously without the requisite qualifications, such as adaptability, shrewdness and practice. Hundreds of different combinations of cards are laid out in books of instructions on auction bridge, with explicit directions as to how to bid and play the hands, yet nobody ever heard of a good bridge player being made solely from book instruction. One reason is that there are actually millions of combinations of cards. Also in stock trading there is an indefinite number of needful “don’ts” which the most resourceful person can neither contemplate nor anticipate. Every stock market cycle shatters some precedent; every era produces new phenomena. Everyone who has ever studied a book of instructions on how to play golf knows how impossible it is to take up any golf club and make it perform according to schedule. A firm stance, feet well apart, body under full control, the right knee stiff, the left arm almost rigid as it follows the right in a low backward swing; and most important of all, the eye firmly fixed on the ball, while the club whips through the air, and after lifting the ball, follows on through, carrying both arms forward to their full length, and many other things which I never could do, and cannot now recall; all these directions the would-be player will learn as he knows his A, B, C’s; but in his intense eagerness to swat the ball he disregards most, or all, of the stated essentials, and at the moment of impact, while his club is ploughing up the sod two or three inches behind the ball, his eyes are cast heavenward in fervent anticipation of watching its flight. Likewise the speculator figures his profits long before they materialize. The most important thing in golf, and the hardest thing to learn, is to keep the eye on the ball while in the act of hitting it; and the hardest thing to learn in stock trading is to keep the eye off the market, hold firmly and patiently to good resolutions, and not try to get rich too quickly. Both look to be easy, but—

Reducing the whole problem to its simplest form, the stock exchange is a well-organized and honestly conducted market-place where anyone may sell or buy investment or speculative securities, at whatever price anybody else is willing to pay or accept for them. There is no more mysticism about the exchange itself than there is about a book auction room, or any other auction room where articles of merchandise are offered at an upset price, or auctioned off to the highest bidder. A man who buys stocks or bonds for investment is not gambling with anybody that they will go up or down; he buys them because he wants to invest his money and get interest or dividends on it. If a stock bought at $100 a share, paying seven per cent. annually in dividends, should increase in market value to $150 it is obvious that the rate of interest on the total capital is correspondingly reduced, and that whereas his original $10,000 brought a return of seven per cent., the capital of $15,000 is earning a net return of only four and six tenths per cent. Under such conditions it is oftentimes wise to sell out and reinvest the money in other securities which bring a larger net return; or if stocks in general are too high, put the money in the bank and wait for lower prices. The $5000 gain in capital will surely more than cover interest on the original $10,000 investment during the time one has to wait for good buying opportunities.

This reminds me that some years ago, when Calumet & Hecla Mining stock was selling at $850 a share, on which amount it netted only a small dividend return, I asked a friend (who owned a large amount of the stock) why he didn’t sell it and reinvest in other securities. My argument was that the stock having already declined from $1000 a share, would probably go much lower, considering that the earning capacity of the mine was in all probability as great as it ever would be; therefore the chances were more in favor of a decrease than an increase in earnings and dividends. To all of which he readily assented, but in view of the fact that he had bought the stock at $50 a share it was paying a very high rate of interest on his original investment; and for sentimental reasons he preferred to keep it,—which he did. Such instances are not at all uncommon; nor is it uncommon to hear intelligent business men remark that they know they ought to sell certain investment securities, because the market price has risen out of all proportion to the income yield, but other good securities are all so high that they really don’t know what to put their money in. The chances are probably a hundred to one that if the money were put in the bank and allowed to rest a while at three per cent. interest, it could within a few months be reinvested in the same securities, or other equally good ones, at a net gain of three to five years’ interest, or even more. This is not stock gambling; it is merely business prudence.