Popular Fallacies of Speculation

THOMAS GIBSON IN MOODY‘S MAGAZINE May 1 1906

Popular Fallacies of Speculation

THOMAS GIBSON IN MOODY‘S MAGAZINE May 1 1906

Popular Fallacies of Speculation

BY THOMAS GIBSON IN MOODYS MAGAZINE.

In the average speculation there is a good deal of blind plunging. Very few operators put any research or reasoning into their trading, and consequently fall down. They are content to accept well-worn aphorisms, which are in reality utter fallacies.

THAT a majority of the speculators designated as “the public” lose money, is a notorious fact. They buy at the top and sell at the bottom; they make favorites of the worst stocks, and utterly neglect the best ones. They are seldom material gainers in an important advance, and are invariably losers in a collapse. The most remarkable feature of all is that they never seem to profit much by their experiences, and do not even attempt to discover why this deplorable state of affairs exists.

If a number of general traders were asked to give reasons for their repeated failures, they would probably attribute them to manipulation, lack of inside information, etc. Mere interested observers on being asked the same question gravely reply that the public loses money on account of buying at high prices ; but this explanation is valueless unless accompanied with the reason why they buy at high prices.

The fact of the matter is that

most speculative losses may be traced to the absence of anything remotely resembling clear reasoning or intelligent research. The speculator begins wrong ; he assumes that he must depend upon tips or chance for his success, or, worse still, forms wrong conclusions from superficial appearances or personal prejudices. The successful trader, on the other hand, goes behind appearances, and has no prejudices. He gets to the bottom of the matter. The ‘‘inside information” and manipulation on which he is popularly supposed to base his success exist largely in the imagination of unsophisticated people. True, many movements are assisted by manipulation, and some depend upon it entirely, but in most cases there is another and more solid basis than the mere operation of the machinery of the Exchange. Again, a purely speculative movement depends largely upon the mistaken attitude (ÿ the public itself.

The public must be arrayed on the wrong side : it is impossible to

manipulate successfully with no one to manipulate against. There must be money in sight.

So vague is the general understanding as to what is necessary to a successful campaign on the part of insiders, and so fixed is the idea of mystery and intricacy, that any attempt to approach the subject from a logical or analytical standpoint is usually greeted with a smile of derision, and yet the difference between the best trader and the poorest is mainly a mental one. It is not meant to say that the unsuccessful traders are incapable of clear reasoning,—some of them are capable enough, but they make no attempt to reason.

To illustrate this : At the out-

break of the late Russo-Japanese war a certain Chicago Board of Trade house with a large clientele pointed out the fact in their daily letter that this particular war was not a bull argument on wheat because “one country was an exporter and the other a non-consumer of wheat.” The euphonious sentence was widely quoted as a good argument. It was simply accepted without analysis. A little reflection makes its fallacy apparent. The reduction of supply at any point is a legitimate argument for higher prices. There is that much less wheat in the world. It would be just as intelligent to state that a handful of grain could be taken from a peck measure without reducing the contents. As untenable as such reasoning appears, it is only a fair sample of the basic arguments upon which men capable of better things hazard their money.

But perhaps it will be said that the case pointed out would have deceived only the most unsophisticat-

ed ; it may appear in this light because of being accompanied by an immediate exposure. Let us consider another case so well known and widely accepted as to be almost axiomatic : “Limit your losses and let your profits run,” is considered an excellent motto by many traders, even experienced ones, and yet if the principle involved is subjected to a little scrutiny, it resolves itself into an inconsequential figment.

The trader who adopts this method must admit, to begin with, that he is merely gambling without any idea of what he is about. He buys or sells on the principle that if he is right he will take a large profit, and if he is wrong, he will take a small loss. A tempting proposition on its face, but founded on exactly the same basis as betting on “long shots” in a horse race.

And here a brief digression is warranted. It is probable that, guided by the suggestions offered above, many readers will be able to lay this article aside, and, by a little reflection, uncover for themselves the weakness of the “long-profit and short-loss” theory without recourse to the exposure which follows. If this is the case it is a timely and convincing proof of the contention already made that it is a lack of directed effort rather than inability which takes the speculator into crooked by-paths.

To contend that there is any inherent quality in the stock market, when considered as a mere gambling machine, which would cause it to produce one profit of ten points more frequently than ten losses of one point each, is to overthrow the entire calculus of probabilities. If such were the case, the entire problem of successful speculation would be

solved. The trader could leave cer tain instructions as to his operations, and go about his business with a surety of ultimate profit.

Perhaps the votaries of this method will object to so broad an application, and point out that they do not so utilize the rule, but that they employ it for purchases on the eve of a probable advance of considerable proportions. This is amusing ; if an advance were probable, how ridiculous to buy at a certain point, and sell at a point where purchases are still more desirable. It would appear that if the system possessed any merit at all it would be most useful at high prices, when purchases were being made in the hope of a purely speculative advance, and losses limited as a precaution in the event of its not appearing. This view of the case may be dismissed by saying that no one has any business speculating on any such premises.

Twist the apothegm as you will, it cannot be made to conform with reason. It is one of a long series of errors which lie in the path of the speculator because of his failure to think correctly, or to dissect the statements which are offered for his edification. The numerous rules and theories which tend to supplant good reasons for purchases and sales with merely mechanical gambling systems, are one and all of exactly as much use as the systems employed by certain faro-bank players or other gamblers.

In every brokerage office may be found individuals laboriously keeping records of figures and movements for the purpose of forming charts and systems. These deluded people work hard at their compilations ; they lose their money, and in some

cases the money of their friends, ia pursuing an ignus fatuus. There is nothing to laugh at—it is too bad.

One of the most serious errors made by the business man who speculates occasionally is the entir« misunderstanding, or one might better say, the misapplication of the word “speculation.” To talk of speculating on the present is a paradox, a flat contradiction of terms, but, nevertheless, the principal reason for general public purchases at high prices is that people base their purchases on what is now self-evident, rather than on future probabilities. The publication of splendid earnings, the existence of good general conditions, and the activity of quotations at high prices attract the cliff-dwellers to the market after all the prosperity has been discounted, or more than discounted in current prices. The true speculator would foresee such a state of affairs, and buy in advance of such announcements. The point at which the public is attracted is, if anything, the place to sell, for every period of high prices will be followed in time by a period of low ones. And as the public traders buy at the top, it naturally follows that they sell at the bottom, for at low prices the signs of prosperity which incited purchasers are supplanted by blueness and general depression.

Thus, a great many people do not speculate at all; they merely act on what is before them, not on what the future holds.

Do you think for an instant that this ill-founded form of operations is confined to tie small fry1? Not at all Good appearances bring to the market business men and bankers in great numbers.

And the semi-professional specula-

tors, that large class who year after year devote their income and capital to an unsuccessful attempt to make a permanent gain, until at length they are incapacitated or disgusted— they also suffer from incomplete and incorrect reasoning. These men pride themselves on being posted, but in most cases their knowledge is of a jug-handle sort. They are students either of values, or of technicalities, seldom of both.

To be more explicit, there are two ©lasses of these semi-professional traders, one operating on intrinsic valuation, regardless of surrounding conditions, and the other doing just the reverse. They may be compared on the one hand with the theorist who understands the philosophy of steam, but knows nothing of the practical working of an engine, and, on the other, to the practical engineer who knows nothing of the philosophy of steam. A thorough understanding of both is essential to a high degree of proficiency.

As an illustration of the difficulties encountered by the first class, the recent movements in Steel Preferred form a good example. This stock is named merely because its movements happen to be best recollected by the general trader. The student of values bought the stock because he believed it to be cheap at 75 ; and so it was, but what followed ? The stock subsequently sold under 50, and was, therefore, a bad speculative purchase at 75. (Investment is not here discussed.) Had the purchaser known, or taken the trouble to inform himself that the stock was largely in public, i.e., weak hands, and applied to this knowledge the reflection that it was highly improbable that any considerable advance would occur under such

circumstances, but that every means would be used to dislodge these holdings—he would have been constrained to wait, would have refrained from making his purchases until it was apparent that the public had parted with steel stocks. This period was in no way obscured from view, for after Steel Preferred had sold at 49f and recovered to 65, there was not a brokerage office in the United States which did not have short commitments in this stock, and very few long ones. At this stage it would not require much profundity to deduce that if the public had parted with their holdings they must perforce rest in strong hands, and following this with the simple question, “What is now to be accomplished V’ the correct solution would have been apparent. So far as the value of the shares was concerned, there was never a time when an intelligent investigator could have found any room to question their value. The public cried “watered stock,” “ruined business,” etc., without the faintest idea what they were talking about.

And the “tape-readers” are no better off. They believe that by the adoption of certain methods, and by the observation of market action they can make money speculating. A few of them succeed, but it would not be amiss to hazard a guess that even these few do not confine their operations to “tape-reading,” but have good ideas of values.

Knowledge of values is absolutely essential. No amount of subsidiary knowledge will do, not even if it includes correct information as to the position of shares. The great professionals are not omnipotent; sometimes they are caught in a position which they cannot abandon. It is

not enough to know that stocks are well located, nor is it enough to know that they are cheap. It is necessary that both these things should be known.

“The ticker never lies,” say the tape-readers. It lies horribly. The same appearances which mark the beginning and upward progress of a bull market are present in an exaggerated form at its culmination. So long as the tape-reader is operating with the long swing of the market he is all right, but as he never sees the top, he generally manages to get loaded up with a considerable line at high prices. And here enters an element of human weakness which is wholly unphilosophical, but very prevalent. Nine men out of ten who find themselves committed to a losing position will stubbornly refuse to alter or abandon it. They cannot, or will not, accept a loss until forced to do so, even if the reasons for their original purchases have been cancelled, or reversed. A few traders school themselves so rigidly as to overcome this defect, and are able to sell and buy regardless of profit or loss, but they are exceptions.

The “one-idea” man is another public loser. lie buys his favorite commodity at a certain price, without regard to the trend of the market. It must be admitted that prices of stocks move from one extreme to the other, and that while a stock might be a good enough purchase at par on the upward swing, it would be a very poor one at the same price in a period of decline.

It is well to know what has happened in the past ; in fact, it is essential, but the knowledge must be used intelligently. Complete analogy is valuable, imperfect analogy is use-

less. To know that a certain stock is in strong hands at a price below its value is a case where what happened before may be confidently expected to happen again, but to merely know that a stock is now selling as low as it sold in last year’s decline is of no use whatever.

There is a general idea that the affairs of speculation are too intricate, too mysterious for solution by the ordinary mind. But this opinion is premature. There is more or less intricacy, it is true, but it is submitted that an understanding of such intricacy is necessary to success, and, furthermore, the most intricate machine appears simple enough to the man who knows all its parts and their application. If any individual honestly tries to understand the matter and fails, he should abandon ventures entirely.

There is no basis for success but knowledge. There is a false appearance of profundity about the subject considered in toto which disappears when each question is separated and examined.

It is not claimed that the matter in this article contains any individual illustrations or statements of particular value to the speculator. The object sought is to direct attention to the necessity of injecting the unusual element of reason into speculative operations, to stimulate right thinking, and to give impressiveness to the statement that each man must go to the last analysis of his subject before venturing his money.

The contention is made that not one single permanent success has ever been made speculatively through chance, through tips, or by any other method than experience and careful analysis. As to the difficulty of

reaching the necessary degree of proficiency, it is believed that there are men of sound judgment and sufficient experience operating to-day, who, by discarding the accepted fallacies bearing on the subject, obliterating

entirely the illusion of hope, and accepting nothing on faith, would find themselves, step by step, arriving at correct conclusions with a facility and accuracy which would surprise no one so much as themselves.