In a classic, “ An Investor’s Anthology”, there is a brilliant piece by George Selden written in 1912.
“It is hard for the average man to oppose what appears to be the general drift of public opinion. In the stock market this is perhaps harder than elsewhere; for we all realize that the prices of stocks must, in the long run, be controlled by public opinion. The point we fail to remember is that public opinion in a speculative market is measured in dollars, not in population. One man controlling one million dollars has double the weight of five hundred men with one thousand dollars each. Dollars are the horsepower of the markets—the mere number of men does not signify.
This is why the great body of opinion appears to be bullish at the top and bearish at the bottom. The multitude of small traders must be, as a plain necessity, long when prices are at the top, and short or out of the market at the bottom. The very fact that they are long at the top shows that they have been supplied with stocks from some source.
Again, the man with one million dollars is a silent individual. The time when it was necessary for him to talk is past—his money now does the talking. But the one thousand men who have one thousand dollars each are conversational, fluent, verbose to the last degree.
It will be observed that the above course of reasoning leads up to the conclusion that most of those who talk about the market are more likely to be wrong than right, at least so far as speculative fluctuations are concerned. This is not complimentary to the “moulders of public opinion,” but most seasoned newspaper reader will agree that it is true. The daily press reflects, in a general way, the thoughts of the multitude, and in the stock market the multitude is necessarily, as a logical deduction from the facts of the case, likely to be bullish at high prices and bearish at low.
It has often been remarked that the average man is an optimist regarding his own enterprises and a pessimist regarding those of others. Certainly this is true of the professional trader in stocks. As a result of the reasoning outlined above, he come habitually to expect that nearly every one else will be wrong, but is, as a rule, confident that his own analysis of the situation will prove correct. He values the opinion of a few persons who he believes to be generally successful; but aside from these few, the greater the number of the bullish opinions he hears, the more doubtful he becomes about the wisdom of following the bull side.
This apparent contrariness of the market, although easily understood when its causes are analyzed, breeds in professional traders a peculiar sort of skepticism—leads them always to distrust the obvious and to apply a kind of inverted reasoning to almost all stock market problems. Often, in the minds of traders who are not naturally logical, this inverted reasoning assumes the most erratic and grotesque forms, and it accounts for many apparently absurd fluctuations in prices which are commonly charged to manipulation.
For example, a trader starts with this assumption: The market has had a good advance; all the small traders are bullish; somebody must have sold them stock which they are carrying; hence the big capitalists are probably sold out or short and ready for a reaction or perhaps for a bear market. Then if a strong item of bullish news comes out—one, let us say, that really makes an important change in the situation—he says, “Ah, so this is what they have been bulling the market on! It has been discounted by the previous rise.” Or he may say, “They are putting out this bull news to sell stocks on.” He proceeds to sell out any long stocks he may have or perhaps to sell short.
His reasoning may be correct or it may not; but at any rate his selling and that of others who reason in a similar way is likely to produce at least a temporary decline on the announcement of the good news. This decline looks absurd to the outsider and he falls back on the old explanation “All manipulation.”
The same principle is often carried further. You will find professional traders reasoning that favorable figures on the steel industry, for example, have been concocted to enable insiders to sell their steel; or that gloomy reports are put in circulation to facilitate accumulation. Hence they may act in direct opposition to the news and carry the market with them, for the time at least.
The less the trader knows about the fundamentals of the financial situation the more likely he is to be led astray in conclusions of this character. If he has confidence in the general strength of conditions, he may be ready to accept as genuine and natural a piece of news which he would otherwise receive with cynical skepticism and use as a basis for short sales. If he knows that fundamental conditions are unsound, he will not be so likely to interpret bad news as issued to assist in accumulation of stocks.
The same reasoning is applied to large purchases through brokers known to be associated with capitalists. In fact, in this case we often hear a double inversion, as it were. Such buying may impress the observer in three ways:
- The “rank outsider” takes it a face value, as bullish.
- A more experienced trader may say, “If they really wished to get the stocks they would not buy through their own brokers, but would endeavor to conceal their buying by scattering it among other houses.”
- A still more suspicious professional may turn another mental somersault and say, “They are buying through their own brokers so as to throw us off the scent and make us think someone else is using their brokers as a blind.” By this double somersault such a trader arrives at the same conclusion as the outsider.
The reasoning of traders becomes even more complicated when large buying or selling is done openly by a big professional who is know to trade in and out for small profits. If he buys 50,000 shares, other traders are quite willing to sell to him and their opinion of the market is little influenced, simply because they know he may sell 50,000 the next day or even the next hour. For this reason great capitalists sometimes buy or sell through such big professional traders in order to execute their orders easily and without arousing suspicion. Hence the play of subtle intellects around big trading of this kind often becomes very elaborate.
It is to be noticed that this inverted reasoning is useful chiefly at the top or bottom of a movement, when distribution or accumulation is taking place on a large scale. A market which repeatedly refuses to respond to good news after a considerable advance is likely to be “full of stocks.” Likewise a market which will not go down on bad news is usually “bare of stock.”
Between the extremes will be found long stretches in which capitalists have very little cause to conceal their position. Having accumulated their lines as low as possible, they are then willing to be known as the leaders of the upward movement and have every reason to be perfectly open in their buying. This condition continues until they are ready to sell. Likewise, having sold as much as they desire, they have no reason to conceal their position further, even though a subsequent decline may run for months or a year.
It is during a long upward movement that the “lamb” makes money, because he accepts facts as facts, while the professional trader is often found fighting the advance and losing heavily because of the overdevelopment of cynicism and suspicion.
The successful trader eventually learns when to invert his natural mental processes and when to leave them in their usual position. Often he develops a sort of instinct which could scarcely be reduced to cold print. But in the hands of the tyro this form of reasoning is exceedingly dangerous, because it permits of putting an alternate construction on any event. Bull news either (1) is significant of a rising trend of prices, or (2) indicates that “they” are trying to make a market to sell on. Bad news may indicate either a genuinely bearish situation or a desire to accumulate stocks at low prices.
The inexperienced operator is therefore left very much at sea. He is playing with the professional’s edged tools and is likely to cut himself. Of what use is it for him to try to apply his reason to stock market conditions when every event may be doubly interpreted?
Indeed, it is doubtful if the professional’s distrust of the obvious is of must benefit to him in the long run. Most of us have met those deplorable mental wrecks, often found among the “chairwarmers” in brokers’ offices, whose thinking machinery seems to have become permanently demoralized as result of continued acrobatics. They are always seeking an “ulterior motive” is everything. They credit—or debit—Morgan and Rockefeller with the smallest and meanest trickery and ascribe to them the most awful duplicity in matters which those “high financiers” would not stoop to notice. The continual reversal of the mental engine sometimes deranges its mechanism.
Probably no better general rule can be laid down than the brief one, “Stick to common sense.” Maintain a balanced, receptive mind and avoid abstruse deductions. A few further suggestions may, however, be offered:
If you already have a position in the market, do not attempt to bolster up your failing faith by resorting to intellectual subtleties in the interpretation of obvious facts. If you are long or short of the market, you are not an unprejudiced judge, and you will be greatly tempted to put such an interpretation upon current events as will coincide with your preconceived opinion. It is hardly too much to say that this is the greatest obstacle to success. The least you can do is to avoid inverted reasoning in support of your own position.
After a prolonged advance, do not call inverted reasoning to your aid in order to prove that prices are going still higher; likewise after a big break do not let your bearish deductions become too complicated. Be suspicious of bull news at high prices, and of bear news at low prices.
Bear in mind that an item of news usually causes but one considerable movement of prices. If the movement takes place before the news comes out, as a result of rumors and expectations, then it is not likely to be repeated after the announcement is made; but if the movement of prices has not preceded, then the news contributes to the general strength or weakness of the situation and a movement of prices may follow.
CONFUSING THE PRESENT WITH
THE FUTURE-DISCOUNTING
It is axiomatic that inexperienced traders and investors, and indeed a majority of the more experienced as well, are continually trying to speculate on past events. Suppose, for example, railroad earnings as published are showing constant large increases in net. The novice reasons, “Increased earnings mean increased amounts applicable to the payment of dividends. Prices should rise. I will buy.”
Not at all. He should say, “Prices have risen to the extent represented by these increased earnings, unless this effect has been counterbalanced by other considerations. Now what next?”
It is a sort of automatic assumption of the human mind that present conditions will continue, and our whole scheme of life is necessarily based to a great degree on this assumption. When the price of wheat is high farmers increase their acreage because wheat-growing pays better; when it is low they plant less. I remember talking with a potato-raiser the above custom. When potatoes were low he had planted liberally; when high he had cut down his acreage—because he reasoned that other farmers would do just the opposite.
The average man is not blessed—or cursed, however you may look at it—with an analytical mind. We see “as through a glass darkly.” Our ideas are always enveloped in a haze and our reasoning powers work in a rut from which we find it painful if not impossible to escape. Many of our emotions and some of our acts are merely automatic responses to external stimuli. Wonderful as is the development of the human brain, it originated as an enlarged ganglion, and its first response is still practically that of the ganglion.
A simple illustration of this is found in the enmity we all feel toward the alarm clock which arouses us in the morning. We have carefully set and wound that alarm and if it failed to go off it would perhaps put us to serious inconvenience; yet we reward the faithful clock with anathemas.
When a subway train is delayed nine-tenths of the people waiting on the platform are anxiously craning their necks to see if it is coming, while many persons on it who are in danger of missing an engagement are holding themselves tense, apparently in the effort to help the train along. As a rule we apply more well-meant, but to a great extent ineffective, energy, physical or nervous, to the accomplishment of an object, than to analysis or calculation.
When it comes to so complicated a matter as the price of stocks, our haziness increases in proportion to the difficulty of the subject and out ignorance of it. From reading, observation and conversation we imbibe a miscellaneous assortment of ideas from which we conclude that the situation is bullish or bearish. The very form of the expression “the situation is bullish”—not “the situation will soon become bullish”—shows the extent to which we allow the present to obscure the future in the formation of our judgment.
Catch any trader and pin him down to it and he will readily admit that the logical moment for the highest prices is when the news after it comes out—if not at the moment, at any rate “on a reaction.”
Most coming events cast their shadows before, and it is on this that intelligent speculation must be based. The movement of prices in anticipation of such an event is called “discounting,” and this process of discounting is worthy of a little careful examination.
The first point to be borne in mind is that some events cannot be discounted, even by the supposed omniscience of the great banking interests—which is, in point of fact, more than half imaginary. The San Francisco earthquake is the standard example of an event which could not be foreseen and therefore could not be discounted; but an event does not have to be purely an “act of God” to be undiscountable. There can be no question that our great bankers have been as much in the dark in regard to some recent Supreme Court decisions as the smallest “piker” in the customer’s room of an odd-lot brokerage house.
If the effect of an event does not make itself felt before the event takes place, it must come after. In all discussion of discounting we must bear this fact in mind in order that our subject may not run away with us.
On the other hand, an event may sometimes be over-discounted. If the dividend rate on a stock is to be raised from four to five per cent, earnest bulls, with an eye to their own commitments, may spread rumors of six or seven per cent, so that the actual declaration of five per cent may be received as disappointing and cause a decline.
Generally speaking, every event which is under the control of capitalists associated with the property, or any financial condition which is subject to the management of combined banking interests, is likely to be pretty thoroughly discounted before it occurs. There is rarely any lack of capital to take advantage of a sure thing, even though it may be known in advance to only a few persons.
The extent to which future business conditions are known to “insiders” is, however, usually overestimated. So much depends, especially in America, upon the size of the crops, the temper of the people, and the policies adopted by leading politicians, that the future of business becomes a very complicated problem. No power can drive the American people. Any control over their action had to be exercised by cajolery or by devious and circuitous methods.
Moreover, public opinion is becoming more volatile and changeable year to year, owing to the quicker spread of information and the rapid multiplication of the reading public. One can easily imagine that some of our older financiers must be saying to themselves. “If I only had my present capital in 1870, or else had the conditions of 1870 to work on today!”
A fair idea of when the discounting process will be completed may usually be formed by studying conditions from every angle. The great question is, when will the buying or selling become most general and urgent? In 1970, for example, the safest and best time to buy the sound dividend-paying stocks was on the Monday following the bank statement with showed the greatest decrease in reserves. The market opened down several points under pressure of liquidation, and many standard issues never sold so low afterward. The simple explanation was that conditions had become so bad that they could not get any worse without utter ruin, which all parties must and did unite to prevent.
Likewise in the Presidential campaign of 1900, the lowest prices were made on Bryan’s nomination. Investors said at once, “He can’t be elected.” Therefore his nomination was the worst that could happen—the point of time where the political news became most intensely bearish. As the campaign developed his defeat became more and more certain, and prices continued to rise in accordance with the general economic and financial conditions of the period.
It is not the discounting of an event thus known in advance to capitalists that presents the greatest difficulties, but cases where considerable uncertainty exists, so that even the clearest mind and the most accurate information can result only in a balancing of probabilities, with the scale perhaps inclined to a greater or less degree in one direction or the other.
In some cases the uncertainty which precedes such an event is more depressing than the worst that can happen afterward. An example is a Supreme Court decision upon a previously undetermined public policy which has kept business men so much in the dark that they feared to go ahead with any important plans. This was the case at the time of the Northern Securities decision in 1904. “Big business” could easily enough adjust itself to either result. It was the uncertainty that was bearish. Hence the decision was practically discounted in advance, no matter what it might prove to be.
This was not true to the same extent of the Standard Oil and American Tobacco decisions of 1911, because those decisions were an earnest of more trouble to come. The decisions were greeted by a temporary spurt of activity, based on the theory that the removal of uncertainty was the important thing; but a sensational decline started soon after and was not checked until the announcement that the Government would prosecute the United States Steel Corporation. This was deemed the worst that could happen for some time to come, and was followed by a considerable advance.
More commonly, when an event is uncertain the market estimates the chances with considerable nicety. Each trader backs his own opinion, strongly if he feels confident, moderately if he still has a few doubts which he cannot down. The result of these opposing views may be stationary prices, or a market fluctuating nervously within a narrow range, or a movement in either direction, greater or smaller in proportion to the more or less emphatic preponderance of the buying or selling.
Of course it must always be remembered that it is dollars that count, not eh number of buyers or sellers. A few great capitalists having advance information which they regard as accurate may more than counterbalance thousands of small traders who hold an opposite opinion. In fact, this is the condition very frequently seen.
Even the operations of an individual investor usually have an effect on prices pretty accurately adjusted to his opinions. When be believes prices are low and everything favors an upward movement, he will strain his resources in order to accumulate as heavy a load of securities as he can carry. After a fair advance, if he sees the development of some factor which might cause a decline—though he doesn’t really believe it will—he thinks it wise to lighten his load somewhat and make sure of some of his accumulated profits. Later when he feels that prices are “high enough,” he is a liberal seller; and if some danger appears while the level of quoted values continues high, he “cleans house,” to be ready for whatever may come. Then if what he considers an unwarranted speculation carries prices still higher, he is very likely to sell a few hundred shares short by way of occupying his capital and his mind.
It is, however, the variation of opinion among different men that has the largest influence in making the market responsive to changing conditions. A development which causes one trader to lighten his line of stocks may be regarded as harmless or even beneficial by another, so that he maintains his position or perhaps buys more. Out of a worldwide mixture of varying ideas, personalities and information emerges the average level of prices—the true index number of investment conditions.
The necessary result of the above line of reasoning is that not only probabilities but even rather remote possibilities are reflected in the market. Hardly any event can happen of sufficient importance to attract general attention which some other process of reasoning cannot construe our old friend of the news columns to the effect that “the necessary a large volume of business,” may influence some red-blooded optimist to buy 100 Union, but the grouchy pessimist who has eaten too many doughnuts for breakfast will accept the statement as an evidence of the scarcity of real bull news and will likely enough sell 100 Union short on the strength of it.
It is overextended speculator who causes most of the fluctuations that look absurd to the sober observer. It does not take much to make a man buy when he is short of stocks “up to his neck.” A bit of news which he would regard as insignificant at any other time will then assume an exaggerated importance in his eyes. His fears increase in geometrical proportion to the size of his line of stocks. Likewise the overloaded bull may begin to “throw his stocks” on some absurd story of a war between Honduras and Roumania [sic], without even stopping to look up the geographical location of the countries involved.
Fluctuations based on absurdities are always relatively small. They are due to an exaggerated fear of what “the other fellow” may do. Personally, you do not fear a war between Honduras and Roumania; but may not the rumor be seized upon by the bears as an excuse for a raid? And you have too many stocks to be comfortable if such a break should occur. Moreover, even if the bears do not raid the market, will there not be a considerable number of persons who, like yourself, will fear such a raid, and will therefore lighten their load of stocks, thus causing some decline?
The professional trader, following this line of reasoning to the limit, eventually comes to base all his operations for short turns in the market not on the facts but on what he believes that facts will cause others to do—or more accurately, perhaps, on what he sees that the news is causing others to do; for such a trader is likely to keep his fingers constantly on the pulse of buying and selling as it throbs on the floor of the Exchange or as recorded on the tape.
The non-professional, however, will do well not to let his mind stray too far into the unknown territory of what others may do. Like the “They” theory of values, it is dangerous ground in that it leads toward the abdication of common sense; and after all, other may not prove to be such fools as we think they are. While the market is likely to discount even a possibility, the chances are very much against out being able to discount the possibility profitably.
In this matter of discounting, as in connection with most other stock market phenomena, the most useful hint that can be given is to avoid all efforts to reduce the movement of prices of rules, measures, or similarities and to analyze each case by itself. Historical parallels are likely to be misleading. Every situation is new, though usually composed of familiar elements. Each element must be weighed by itself and the probable result of the combination estimated. In most cases the problem is by no means impossible, but the student must learn to look into the future and to consider the present only as a guide to the future. Extreme prices will come at the time when the news is most emphatic and most widely disseminated. When the point is passed the question must always be, “What next?””