Thomas Gibson had a front-row seat to the speculative madness in Wall Street at the start of the 1900s. He saw traders succeed and (mostly) fail on a regular basis for a decade. In those few successes and many failures, some common themes stood out.
For instance, ignorance, overtrading, and negligence were the main reasons people lost money.
The business method, as he called it, was absent. More often than not, speculators treated the market as a casino rather a place to buy and sell shares of businesses for cash. They knew little about the companies behind the shares they bought — relying on tips over research.
Worst of all, they seemed to do everything backward. The height of speculation was always at market peaks when prices and enthusiasm were highest. But when opportunities were prevalent at lower prices, that interest and enthusiasm had dried up. It seemed as though they wanted quick riches, with little to no effort, or not at all. Slowly wouldn’t do.
Gibson wrapped up those experiences in his first book published in 1906. The Pitfalls of Speculation is a perfect example of how long sound investing principles have been around and how rarely investors heed them. You’ll find some highlights from the book below:
On lessons from successful speculators.
The man who speculates in a business-like way trades only in standard properties with whose history, physical condition, earnings, and prospects he has thoroughly familiarized himself; forms for himself a careful estimate of normal value and uses this value as a gauge by which to decide when prices are too low and too high; takes into consideration also the technical condition of the market, and does not embark with bad company, even at low prices; is not misled by the thrills of inflation, or the chills of depression; operates, not for the purpose of gathering a small profit from many transactions, but to gather a large profit from a few; trades with responsible middlemen, and, above all things, is patient. In short, he maps out for himself an intelligent and well-founded plan of operation, contemplating all that may occur, and having mapped it out, follows it.
Very few speculate in this manner, and — very few succeed.
On knowing what you own.
Few men embark in a business pursuit of any kind without a careful examination of the prospects and environments of their ventures. If a business, or an interest in a business; is to be purchased, the past, present, and probable future of that business are carefully examined. The assets and liabilities are compared, the record of past sales and profits are considered, and the probable future of the community, or territory from which the business draws its revenue, is given particular attention, and also, the danger of a decimation of profits through competition is considered. The character of the individuals concerned as partners or managers is weighed, and if found wanting, the proposition is discarded, as confidence between men is the foundation of all successful combinations.
Neither does the prospective purchaser enter his field without some special education for the business in hand, or at least not without a determination to watch and learn daily something of the technicalities of his enterprise. These simple facts are recognized the world over as merely plain, sensible precautions adopted by all businessmen in all businesses — all except one — the widely patronized business of speculation.
On the importance of valuation.
The great basic principle of speculation, the foundation upon which the entire structure rests, is the recognition of value. No sustained success is possible without this knowledge, and most failures are traceable to the lack of it. Yet so generally is this important element disregarded, or refuted, that we find it playing only a small part, or no part at all, in the operations of the average speculator.
On setting reasonable expectations.
The man who speculates in a business-like manner will at once see the necessity of entirely eliminating abnormal possibilities and rashness from his plan of operation. The difference between expecting from the market what is reasonable, and expecting too much; and between buying what can be reasonably protected, and even increased, and plunging, is exactly the difference between success and failure…
It is one of the many strange facts about the great field of opportunity called speculation, that men who consider ten percent a good return on capital in ordinary business are wholly dissatisfied with one hundred percent in a speculative venture.
On when to sell.
It is, of course, necessary above all things to revert to the estimated and fixed value of the stocks traded in and to find out how much above this normal point the securities are selling. This done, common sense, plus prudence, and minus piggishness, may determine the question and dictate the time for liquidation. This action, however, once decided upon must be adhered to with great rigidity, for thousands of traders who thus take time by the forelock have been dissatisfied afterward by seeing a still greater advance in which they had no interests, and through greed and impatience have re-entered the lists at a most inopportune time.
On the common mistakes in a speculative cycle.
The innate false appearance of speculative surroundings does much to influence public participation at the wrong period. When stocks are low in price the brokerage offices are deserted, the newspapers say little of speculative affairs, transactions are limited, and those who have been worsted in the preceding decline speak in pessimistic terms of the future. A long period of dullness almost invariably follows a severe decline, new lambs must be born and the old ones suffered to grow a new fleece, and dullness is always unattractive. But at the crest of a great movement all is activity. Excited groups gather about the tickers and predict future events founded principally on illusions or hope, and stories of quickly acquired gains are heard on every hand. A fever of speculation fills the air and men who had no thought of venturing during the time of depression and low prices, now purchase anything and everything at prices that are very high.
The mistakes discussed above — ignorance; the belief that speculative riches are the result of luck rather than of judgment, over-speculation, and misleading surface appearances, combine to make it possible for the shrewd and successful minority to buy and sell periodically to great advantage by an almost exact reversal of public methods and beliefs. Their operations are not founded on such reversion, but on study and knowledge of past precedent, present conditions, and future probabilities. The fact that public opinion is diametrically opposed to their views may be cheerfully considered as excellent proof of the correctness of their deductions, as the public is usually wrong.
On trading too much.
Many men with sound ideas, and whose ventures have proved ultimately the correctness of their views, have, by the one fault of over trading, become paupers, when, with business methods, they might have become millionaires.
On the mistake of overpaying at market tops.
Over-speculation, the composite result of ignorance, greed, and false appearances, may be classed as the primary cause of wide variations in prices, for as much too high as a market is carried by rash participation at high prices, just as much too low will it sink in the ensuing decline. The ill-advised traders who rush in at high prices with inadequate capital are the first to suffer; their overthrow topples over other weak accounts, and so on down the line until the last of the wobbly row of bricks has fallen.
The Pitfalls of Speculation
Common Investing Mistakes of the Early 1900s and How to Fix Them
Investing Advice from 1937, Still Relevant Today