The psychology of speculation

by Henry Howard Harper

Of course every banking and brokerage firm has a few customers who go into the market and buy stocks and bonds during seasons of depression and afterwards pay no attention to the daily or weekly fluctuations until prices reach a stage where it seems advisable to sell out; then they dispose of their holdings and leave the market to the traders until bargain day comes round again. But the foregoing examples symbolize the mental attitude and customary procedure of an overwhelming majority of the trading public. This being true, one may draw from them some idea of how important a part psychology plays in the destinies of those who speculate. It would be erroneous to suppose that the characters who play these rôles are shallow-brained dolts because their actions (judged by results) appear nonsensical to the rational and composed mind. On the contrary, the speculative element represents for the most part men of uncommon shrewdness and foresight; men of studious and analytical minds; men who are, or have been, masters of every situation in their own professions or commercial vocations, even though most of them act like children when they get tangled up in the meshes of stock speculation.

Nor should it be imagined that the stock market is primarily a guessing game, or a game of chance; or even an unbeatable game; or that it is run by a gang of swindlers or mountebanks. Gamesters and swindlers may play at it, but the game itself is as straight and legitimate as any business pursuit. As a matter of fact it is one of the fairest and most open games ever played; a game in which every participant, man or woman, rich or poor, old or young, has an equal chance. The fact that most people resort to mere guessing and gambling in their stock transactions does not make it necessary to qualify this statement; neither is the truth of the assertion altered by the fact that certain individuals and organized cliques of traders manipulate stocks, both up and down, with utter disregard of basic values, and in this way set cleverly baited traps for other traders who imagine themselves wise enough to pluck the bait and get away without springing the trap. A trader or investor in stocks is not obliged to participate in these machinations, any more than one who goes to a circus is obliged to bet on the shell games and other tricky money-making devices that are sometimes run in conjunction with traveling menageries, but are no part of the main performance.

A person who buys a piece of improved real estate for less than half of its actual worth is reasonably sure he has a bargain; but if he afterwards sells it at a fair price, and later buys it back again at a much higher figure, he is gambling that for some reason or other it is going to be worth more, either actually or fictitiously. Nor is it ever unsafe to buy good stocks at figures away below their intrinsic worth. The element of gambling does not enter the undertaking until the market price has risen above the investment value; then if the owner refuses to sell, or buys more (as the speculator usually does) he is gambling on the uncertain event that some individual or clique is going to pay him more than the stock is worth. When one buys a stock, either for investment or speculation, its value cannot be permanently affected by the action of other traders, and no individual or group of individuals can euchre an investor out of his stock except by his own free will. The man with a hundred dollars has the same relative chance for making money as the man with a million; but the difficulty is that the one with the smaller amount is ambitious to make equally as much as the one with the million; therefore he resorts to gambling on thin margins; and not being content with ordinary risks he plays a long chance shot. If he wins, instead of withdrawing the original capital, with perhaps a little more, he usually stakes the whole amount on every venture until it is lost.

Viewing the stock market calmly in the perspective, it is not a question whether stocks will rise or fall; of that there is not the slightest doubt. They rise and decline with the same certainty that the sun rises and sets, though of course with less regularity. The only question is, how far they will go in either direction.

The action of the stock market much resembles that of a troubled sea, which is always uneasy, rolling and tumbling about as if undermined by some volcanic force. The prices of stocks are periodically rising and falling, and one might as well undertake to fight the ocean tide as to contest the course of the stock market when once in full swing in either direction; for the market, unlike the tide, has no prescribed boundaries. There are times—indeed most of the time—when it is much wiser to sit by in the capacity of an interested observer, than to plunge in and become a struggling participant, with the chance of being carried out beyond one’s depth. Theoretically, there seems to be no reason why the stock market should not move along at a fairly even pace, except in case of some unexpected crisis; but practically, it is either abnormally high or unreasonably low most of the time. Stocks, like food, clothing and all human necessities, are more or less subject to the laws of supply and demand; and when the traders and investors throughout the country become convinced that it is time to buy stocks, a bull market is sure to ensue; then when everybody has acquired all they want—and some of them more—and they make up their minds to sell, it is only natural that values should recede; which they do, usually to somewhere near the low point from where they began to rise. This process of sliding up and down the scale is repeated year after year, and age after age.

No one has ever been able satisfactorily to explain why the prices of all stocks, both good and poor, and even gilt edge bonds, keep an almost even pace in the backward and forward swings, but they do; and thousands of people who have placed their savings in securities that are as sound and safe as a savings bank have viewed with alarm the crumbling market values of their investments, wondering what has happened to their particular stocks or bonds, and if the slumping prices foreshadow a reduction in dividends, or if interest will be defaulted on coupons. Investors who own bonds or good dividend paying stocks need not be troubled over these capricious changes; but others of a more venturesome or speculative bent are forever wondering when they ought to get in or out. Of this latter class it is the best guessers who win.

SOME SIGNS ARE COMPREHENDIBLE; OTHERS
ARE HARD TO INTERPRET

It has been wisely observed by one who is more famous for the wisdom of his writings than for the amount of money he has made in speculation, that when a market reaches the top there is no visible sign to indicate it; that on the contrary, at this critical point, everything seems to indicate much higher prices. Also the majority of traders, tipsters, financial editors, and even the brokers themselves, are apt to be most bearishly disposed when the market is at its lowest point. This same authority declares that when the “cats and dogs,” that is, the poorest and most neglected stocks in the list, begin to advance it is time for holders of securities to cash in their profits. It might be further observed that when plums get ripe and the melon season is on, it is a sure indication that summer is well advanced; likewise when, after a long season of bullish anticipation, the stock market “plums” are being distributed, and the “melon-cutting” process is in full swing—when the favorite “mystery” stocks have disgorged their “hidden assets,” and begin to sell ex-rights, ex-dividend, ex-merger and ex-mystery, it is a pretty sure sign that the “bulls” are running short of provender, and that the “bears” are about due for their inning. A man who accumulates large paper profits in speculation and fails to “cash in” until a large part, or all, of his gains have been dissipated in the process of deflation which inevitably follows every boom, is comparable to one who plants a field of grain and refuses to harvest it at maturity, hoping that the ripened kernels will get a little larger. Many a speculator has been brought to grief by an insatiate greed for that coveted topmost point, instead of being content to sell at a good profit and leave the possibility of a small gain to the individual who buys his stock.