Preface
This book is based upon the belief that the movements of prices on the exchanges are dependent to a very large degree on the mental attitude of the investing and trading public. It is the result of years of study and experience as fellow at Columbia University, news writer, statistician, on the editorial staff of The Magazine of Wall Street, etc.
The book is intended chiefly as a practical help to that considerable part of the community which is interested, directly or indirectly, in the markets; but it is hoped that it may also have some scientific value as a preliminary discrussion in a new field, where opportunities for further research seem almost unlimited.
G. C. Selden.
New York, May 28, 1912
Ⅰ. The Speculative Cycle
Most experienced professional traders in the stock martet will readily admit that the minor fluctuations, amounting to perhaps five or ten dollars a share in the active speculative issues, are chielfy psychological. They result from varying attitudes of the public mind, or, more strictly, from the mental attitudes of those persons who are interested in the market at the time.
Such fluctuations may be, and often are, based on “fundamental” conditions – that is, on real changes in the dividend prospects of the stocks affected or on variations in the earning power of the corporations represented – and again they may not. The broad movements of the market, covering periods of months or even years, are always the result of general financial conditions; but the smaller intermediate fluctuations represent changes in the state of the public mind, which may or may not coincide with alterations in basic factors.
To bring out clearly the degree to which psychology enters into the stock market problem from day to day, it is only necessary to reproduce a conversation between professional traders such as may be heard almost any day in New street or in the neighboring cafes.
“Well, what do you know?” says one trader to the other. “Just covered my Steel,” is the reply. “Too much company. Everybody seems to be short.”
“Everbody I’ve seen thinks just as you do. Each one has covered because he thinks everybody else is short – still the market doesn’t rally much. I don’t believe there’s much short interest left, and if that’s the case we shell get another break.”
“Yes, that’s what they all say – and they’ve all sold short again because they think everybody else have covered. I believe there’s just as much short interest now as there was before.”
It is evident that this series of inversions might be continued indefinitely. These alert mental acrobats are doing a succession of flip-flops, each one of which leads up logically to the next, without ever arriving at final stopping-place.
The main point of their argument is that the state of mind of a man short of the market is radically different from the state of mind of one who is long. Their whole study, in such a conversation, is the mental attitude of those interested in the market. If a majority of the volatile classs of in-and-out traders are long, many of them will hasten to sell on any sign of weekness and a decline will result. If the majority are short, they will buy on any development of strength and an advance may be expected.
The pstchological aspects of speculation may be considered from two points of view, equally important. One question is, What effect do varying mental attitudes of the public have upon the course of prices? How is the character of the market influenced by psychological conditions?
A second consideration is, How does the mental attitude of the individual trader affect his chances of success? To what extent, and how, can he overcome the obstacles placed in his pathway by his own hopes and fears, his timidities and his obstinacies?
These two points of view are so closely involved and intermingled that it is almost impossible to consider either one alone. It will be necessary to take up first the subject of speculative psychology as a whole, and later to attempt to draw conclusions both as to its effects upon the martket and its influence upon the fortunes of the individual trader.
As a convenient starting point it may be well to trace briefly the history of the typical speculative cycle, which runs its course over and over, year after year, with infinite slight varieations but with substantial similarity, on every stock exchagne and in every speculative market of the world – and presumably will continue to do so as long as prices are fixed by the competition of buyers and sellers, and as long as human beings seek a profit and fear a loss.
Beginning with a condition of dullness and inactivity, with small fluctuations and very slight public interest, prices begin to rise, at first almost imperceptibly. No special reason appears for the advance, and it is generally thought to be merely temporary, due to small professional operations. There is, of course, some short interest in the market, mostly, at this time, of the character sometimes called a “sleeping” short interest. An active speculative stock is never entirely free from shorts.
As there is so little public speculation at this period in the cycle, there are but few who are willing to sell out on so small on advance, hence prices are not met by any large volume of profit-taking. The smaller professionals take the short side for a turn, with the idea that trifling fluctuations are the best that can be hoped for at the moment and must be taken advantage of if any profits are to be secured. This class of selling brings prices back almost to their former dead level.
Soon another unostentations upward movement begins, carrying prices a trifle highter than the first. A few shreded traders take the long side, but the public is still unmoved and the sleeping short interest – most of it originally put out at much higher figures – still refuses to waken.
Gradually prices harden further and finally advance somewhat sharply. A few of the more timid shorts cover, perhaps to save a part of their profits or to prevent their trades from running into a loss. The fact that a bull turn is coming now penetrates through another layer of intellectual density and another wave of traders take the long side. The public notes the advance and begins to think some further upturn is possible, but that there will be plenty of opportunities to buy on substantial reactions.
Strangely enough, these reactions, expect of the most trifling character, do not appear. Waiting buyers do not get a satisfactory chance to take hold. Prices begin to move up faster. There is a holt from time to time, but when a real reaction finally comes the market looks “too weak to buy,” and when it starts up again it often does so with a sudden leap that leaves would-be purchasers for in the rear.
At length the more stubborn bears become alarmed and begin to cover in large volume. The market “boils,” and to the short who is watching the tape, seems likely to shoot through the ceiling at almost any moment. However firm may be his bearish convictions, his nervous system eventually gives out under this continual pounding, and he covers everything “at the market” with a sigh of relief that his losses are no greater.
About this time the outside public begins to reach the conclusion that the market is “too strong to react much,” and that the only thing to do is to “buy’en anywhere.” From this source comes another wave of buying, which soon carries prices to new high levels, and purchasers congratulate themselves on their quick and easy profits.
For every buyger there must be a seller – Or, more accurately, for every one hundred shares bought one hundred shares must be sold, as the actual number of persons buying at this stage is likely to be much greater than the nuber of persons selling. Early in the advance the supply of stocks is small and comes from scattered sources, but as price rise, more and more holders become satisfied with their profits and willing to sell. The bears, also, begin to fight the advance by by selling short on every quick rise. A stubborn professional bear will often be forced to cover again and again, with a small loss each time, before he finally locates the top and secures a liberal profit on the ensuing decline.
Those selling at this stage are not, as a rule, the largest holders. The largest holders are usually those whose judgment is sound enough, or whose connections are good enough, so that they have made a good deal of money; and neither a sound judgment nor the best advisers are likely to favor selling so early in the advance, when much larger profits can be secured by simply holding on.
The height to which prices can now be carried depends on the underlying conditions. If money is easy and general business prosperous a prolonged bull movement may result, while strained banking resources or depressed trade will set a definite limit to the possible advance. If conditions are bearish, the driving of the biggest shorts to cover will practically end the rise; but in a genuine bull market the advance will continue until checked by sales of stocks held for investment, which come upon the market only when prices are believed to be unduly high.
comments powered by Disqus