The basic principles of sound investing have not changed in a couple of centuries. But neither has the most common errors made by investors.
A perfect example of how little investor misbehavior has changed can be found in a book by Thomas Gibson. Gibson wrote several books on investing and speculation. One of his more recent was published in 1923.
In it, Gibson recounts a study he did of the trading history of some 4,000 brokerage accounts over a 10 year period.
Two patterns really stood out. Far more people bought at high prices than low prices and almost every account that showed some type of plan for buying and selling not only gave up on the plan but would have made a profit had they stuck with it. Overall, losses were an overwhelming result.
His book, The Facts about Speculation, sums up the most common errors he found and the best ways to correct them. You’ll find a few highlights below:
On getting rich quick.
It is necessary to dismiss from the mind, or more properly speaking, from the imagination, any hope of acquiring a large fortune with a small capital in a brief period of time. There is not one chance in a million that any such results can be accomplished through speculation. At particular times great profits are rolled up rapidly because of abnormal conditions, coupled with mere luck. The few who have had fortunes thrust upon them in this way never keep them… The ego is strong in all of us, and each individual flatters himself that if he should make a great profit in a short period he would be wise enough to keep it. But the records do not show that this has ever happened. A man who is bold enough to plunge in such a way as to turn a small amount into a large amount in a short time does not suddenly become conservative. We cannot endow the individual with two antithetical natures…
If at times profits accrue in an unexpectedly rapid manner it is well to look upon this as a fortunate accident, and refuse to be spoiled by it.
On the error of buying high and not buying low.
The most glaring apparent cause of loss revealed in the investigation of these accounts was the almost universal habit of making purchases at high prices after a material rise had already occurred. The error is of a wholly psychological character… Any man of average intelligence will realize and admit that the time to purchase securities is when prices are depressed, not when they are inflated. He will also realize and admit that there is a top to the market and that each point that prices advance brings them that much nearer to the top and consequently curtails the extent of possible profits. Finally, he will realize and admit that the extent to which prices may fall increases with each point of advance. The entire proposition as outlined above is as simple as a law in physics.
The ceiling, as well as the floor of the security markets is invisible to the rank and file, and this is the principal cause of their undoing. The reason for this blindness is easily traced. It is due to the fact that nine speculators out of ten are influenced by surface appearances instead of by knowledge of values and a clear understanding of economic phenomena. It is certain that the surface appearances will always be inspiring when prices are high, and it is equally certain that they will be depressing when prices are low. It could not be otherwise.
The market is forward-looking.
The action of the market represents the composite opinions of the brightest minds in the world registered upon the most delicate instrument in existence as to probable future developments. Intermediate security price movements or movements of individual stocks may at times be due to manipulation and may, therefore, be misleading, but a sustained rise or fall in any group of stocks or in the market as a whole will herald the coming of improvement or retrogression in a certain line of business or in business generally. A charted statistical record of security price movements and general business conditions examined over a long period of time will show that the two have invariably moved in close relation to each other, except that the market precedes the actual business development.
On the error of projecting the present into the future.
The psychologists tell us that one of the most common of human errors is the propensity to assume that present conditions will be indefinitely projected into the future. This is, of course, a mischievous error when applied to the security market. It is simply another way of arguing that the higher prices go the farther they are from the top. But so long as human nature endures this error will persist, and until it is overcome there is little hope of making a success of speculative ventures. We might as well expect a dealer in real estate who purchased property when a boom had almost run its course, or a merchant who stocked up heavily with goods at high prices to succeed.
On market fluctuations.
Unexpected reversals are certain to appear at times and no amount of vigilance or study can provide against this contingency. The only thing which can insure a reasonable degree of safety is a sufficient margin or sufficient reserves at all times. Declines in quoted prices do not necessarily imply any change in the value or future prospects of a corporation or its securities.
On why people are attracted to new stocks.
Greed leads to operations in hazardous and doubtful stocks. There is more chance of a wide price movement in a “mystery” stock than in a stock which can be competently analyzed. Therefore, we find the highly speculative public favoring blind issues which have a wide price range, neglecting to observe that the range may be as wide in one direction as in the other.
On first versus second-level thinking.
Experienced and far-sighted men buy securities because they have reason to believe that profits in a certain line or in all lines will soon increase. The inexperienced public speculator sees no reason for buying at such times, as surface appearances are blue and discouraging. But when expectations of increased profits have crystallized into facts, surface appearances are excellent. Then the psychological error heretofore referred to, i.e., the assumption that present conditions will be projected into the future, begins to get in its work. The fact that security prices have risen to a level which discounts or largely discounts the improvement which has occurred is lost sight of, as is also the fact that both business conditions and the security markets move in cycles; a major recovery being followed by a major recession. The upshot of all this is that public speculative buying reaches its greatest proportions at or near the apex of an upward swing.
On stock prices versus values.
I believe the average man would be better off if he never saw a quotation board or a ticker… Successful speculation is based upon a correct concept of the difference between present prices and probable future values, and speculations based upon any other foundation will fail.
On timing the market.
It is possible to determine on sound and reasonable grounds when securities are cheap in the light of future probabilities. It is also possible to determine when they are dear, but it is not possible to determine when the minor interruptions and reactions will be. These reverses are due to the necessities or whims of thousands of widely scattered speculators, or to accidents, or to some development affecting sentiment, or to technical conditions, or perhaps manipulation.
The psychologists tell us that fear is more contagious than any other emotion, and there is probably no place where fear does more damage than in the securities markets. Even those who have a fair knowledge of values and a soundly based position marketwise, will frequently begin to entertain doubts and misgivings when they see quoted prices moving against them. Those who have no clear idea as to the values and economic prospects are thrown into a cold sweat by every reaction and by the most absurd rumors or inventions. They rush to sell out their holdings and an hour or a day later rush to buy them back, usually at a loss of money and always at a loss of peace of mind.
One of the peculiarities in connection with greed is that a speculator will frequently overextend himself and endanger his entire capital in order to hasten the process of accumulating profits when there is no reason for haste… He seems to harbor the impression that the present opportunity is unusual and that if he does not acquire a huge sum quickly he will never have another chance. Those who are afflicted by this quite human failing should reflect that the stock market has been grinding away for many years and will be grinding away next year and during all the years of his life.
On holding onto losing stocks.
Inability to accept a loss is one of the most common and most mischievous of the numerous errors found in connection with operations in the security markets… It is rather difficult to understand why so many intelligent investors or speculators insist on sticking stubbornly to their original purchases for no reason whatever except that they show a loss. I think the ego must enter into the proposition to a considerable extent. A man does not like to confess his mistakes…
Every man, whether he be an investor or a speculator should school himself against this habit of sticking to a bad bargain in the mere hope that something will happen to bring him out whole. The habit is illogical and expensive, and I regret to say that it is quite prevalent.
Investing Advice from 1937, Still Relevant Today
Lessons from a 300 Year Old Book on Markets