Thomas Gibson’s 1909 classic breaks down the market cycles of the 1800s, the speculative behavior behind them, and the typical errors speculators make each step of the way.
The Notes
- Speculation = “to buy what is cheap and re-sell at a profit.”
- “Speculation contemplates a rise in price, and an accretion in principal. Investment refers to interest returns on money.”
- “Speculation is an inherent part of human nature, and that a majority of human beings are bound to indulge in it in spite of everything.”
- “No one will attempt to deny that a majority of public speculators lose.”
- Speculating vs Gambling
- “It requires only a moment’s reflection to see that in any mechanical gambling game where there is any percentage, no matter how small, in favor of the game, the percentage of players who eventually lose must be 100. This being the case, the gentlemen mentioned were at considerable pains to prove that, as 100 percent of the players did not lose, speculation was not a gambling game in the strict sense of the word. That is to say, it could not be correctly compared with any mechanical device where the element of skill was absent.”
- “If we consider the matter in a gambling light, the percentage against the speculator can be determined by the proportions of commissions, interest, taxes, etc., to capital invested.”
- “There is no doubt that fluctuations in prices of securities, cereals, and staples are frequently used as a basis for mere gambling transactions. But the most remarkable feature of the whole problem is the fact that the percentage of loss in transactions is greater than the mechanical percentage.”
- “We must attribute the surplus loss in speculation to mental operations. In the total results mentioned, these mental operations were so erroneous as to cause a loss greater than the percentage itself.”
- “Trading on insufficient margin is one of the greatest evils in the speculative world and when, as is frequently the case, this evil is combined with lack of knowledge as to values and conditions, the result is certain loss.”
- “One of the most flagrant errors in speculation is an entirely mistaken idea as to the possibilities in this field. Nine men out of ten have a deep-rooted conviction that if any individual could be right in his main deductions for, say one or two years, he should make millions on a small capital. This is a great mistake, and leads to numerous minor errors which are productive of much loss in actual operations.”
- “The business of speculation never did, and never will result in abnormal profits.”
- “No matter how correct the forecast of the future may be, safety disappears in inverse ratio to the increased possibilities of abnormal returns; and with the factor of safety continually ignored, the final results are bound to be disastrous.”
- “If the speculator imagines that he can operate successfully without preliminary hard work to fit him for the business in hand he is grossly mistaken. It is necessary to qualify in this field as well as in any other. Knowledge of monetary conditions, values, interest rates, and in fact, of all influences bearing directly or indirectly on the future of prices must be acquired and thoroughly understood. Ignorance on any one point may mean defeat.”
- “The man who attempts to evade necessary labor and research by placing his dependence on tips or charts, or the opinions of others, can not hope to succeed. The gambling idea must be put out of the question entirely, and means sought whereby intelligent opinions may be formed by both inductive and deductive reasoning.”
- “The great upward and downward swings of speculative prices herein referred to as cycles, have invariably preceded or accompanied periods of business inflation or depression. This fact, apparently so elemental, is often disregarded by that very large class of speculators which is continually looking for artificial and unpregnant explanations of price changes.”
- “Every observer of great speculative movements knows that at the highest point of a movement, and during the first half of a decline everything appears roseate, while at the lowest prices, and during the first half of an advance, the reverse is true.”
- “The most difficult thing to drill into the mind of the unsophisticated is the fact that speculation cannot possibly be successfully based on appearances which are open and obvious. Such a process is a flat contradiction of the word itself. It is unseen future developments or, in some cases, hidden and submerged present truths which must be consulted.”
- “We find a great majority of the public element who seek riches in the speculative arena, constantly harping on the large business of certain corporations and the excellent state of general trade as a reason for purchasing shares. These factors have, in all probability, been discounted in current prices. Generally speaking, the present is of no more use than the past in forming opinions of future price changes.”
- Market Crises in the 1800s
- 1814 — War of 1812 began after 10 years of prosperity. The panic occurred in August 1814 when the British took Washington.
- 1826 — General depression with many failures. The depression was worse in England.
- 1837 — After 6 years of prosperity, the panic struck on May 10, 1837. The crisis was attributed to the great New York fire, United States Bank lost its charter, and President Jackson called in $37.5 million in government deposits.
- 1848 — Prosperity broke with war with Mexico and over-speculation in stocks.
- 1857 — Speculation was at an extreme. Was one of the more serious and short-lived episodes.
- 1864 — Crash came after excess speculation in stocks due to high commodity prices and railroad earnings due to the Civil War.
- 1873 — Market began falling in April 1873 while business was booming.
- 1884 — Several business failures and suspensions set off a panic.
- 1893 — Speculation was rampant. Banks failed and railroads went into receivership. Liabilities tied to business failures in 1893 reached $350 million.
- 1903 — More of a retrenchment than a panic. The bull market was again in full swing the next year.
- “In the majority of instances, highest prices for stocks were reached long before business troubles were openly apparent. This action represents to a certain extent the selling of stocks by men who were wise enough to foresee trouble. Another interesting fact in regard to crises is that they are usually preceded by record-breaking business in all directions.”
- “Any attempt to determine the turning point by examination of advances in prices of stocks or volume of production and consumption of commodities is futile.”
- “It is probable that the most acceptable theory as to the causes of periodicity is the psychological contention. Human nature is much the same throughout the civilized world. We suffer from a panic and a period of depression, and we grow wary and conservative. This course results in sound methods and accumulation. The business structure rests on a firmer foundation. Gradually the hard lessons of the past are forgotten by the older generation and are entirely unlearned by the new business generation, all of whom are optimists. Again we expand our enterprises, again fortune favors us; the appetite for gold grows greater as wealth accumulates; men who were economical and satisfied on modest incomes now live extravagantly, and some of them dream of millions. Capital is spread out thinly. Story after story is erected on one foundation, and that foundation, sound enough at first, eventually gives way. Then we must begin our careful building once more. The ten-year periods, therefore, may represent with more or less accuracy, the lapse of time between wisdom and folly, the yardstick of human intellect and experience.”
- “The depression itself was produced by prior inflation. It was the illness after overstimulation. And so, in turn, we can ask what caused the inflation; and the answer is “Human greed and human folly.” This last analysis brings us around in a circle to the original theory of a psychological cause.”
- “If we scrutinize the history of past crises and great movements with a view to determining the salient causes therefor, a great deal has been gained, for we may apply this knowledge to existent elements lying parallel to those which caused trouble in the past, and thus decide what is probable in the future. If, on the other hand, we place dependence on mere repetition, we gain nothing in education and stand in constant danger.”
- “Prices, not only of shares but of all things, will overleap themselves and will also swing backwards to the other extreme. The cycles are not completed until both zenith and nadir have been touched.”
- “Rising prices of commodities and property encourage speculation in commodities, stocks and real estate and discourage honest industry. Thus, rising prices, by diminishing the incomes of ‘safe’ investments in ‘gilt-edged’ bonds and stocks and by increasing the profits of speculators encourage extravagance, recklessness and thriftlessness.”
- “It will be observed that while stock market movements do not always immediately reflect good or bad conditions in the financial world, the effect is ultimately felt.”
- “It is strangely illogical, but unquestionably true, that people who would flatly refuse to enter a market at a low level of prices will rush in to buy ten points higher if the factors of bustle and excitement are present. Both the doctrine of common sense and the calculus of probabilities would establish the fact that each advance brings us nearer the top, and each decline brings us nearer the bottom, but few men can train themselves away from the idea that an upturn already established does not indicate higher prices and vice versa. It is a sort of enthusiasm which a minority understand, however, and make good use of. The psychological effect of mere excitement is one of the explanations of the incontrovertible fact that the public usually buys at high prices and sells at low prices.”
- “The acceptance of certain periods or seasons as a guide to either purchases or sales of stocks is, in the last analysis, merely a form of chart-playing. It is natural to evade a studious examination of the general business and monetary situation and to resort to a simple, albeit a superficial diagnosis, which, being insufficient and incomplete, is dangerous.”
- January Effect reference: “This occurred in January 1907, and the believers in a “January rise,” were badly disappointed.”
- “We have always at hand statistics which will reflect faithfully the fundamental basis of the entire world structure. But in this important division, as in most other branches of speculation, we often find that what is really important is absolutely ignored, while matters of little moment are harped upon, or even made the basis of operations.”
- “It is almost invariably the case that when a great decline in stock prices occurs, the setback is popularly attributed to some factor which, in reality, had little to do with the reversal.”
- “One of the most remarkable things about speculation is that the true causes of great movements are fully appreciated by the majority only in retrospect.”
- “There is a popular idea that it is dangerous to buy stocks on the eve of a new presidential campaign, but there is not much in history to uphold the view.”
- “No cut and dried rules or suggestions can be offered as to the effects of political or legislative issues on prices. Each point must be scrutinized as it arises, and judgment formed thereon.”
- “Accidents are more frequently the excuse for movements than the cause of them. If a market is in a bad technical or general condition, the slightest adverse happening may create panic; while if the foundation is sound, even a great calamity, such as the San Francisco earthquake, will cause only a temporary halt. The man who speculates correctly has little to fear from accidents.”
- “The chronic short-seller is swimming constantly against the current.”
- Indications of Crisis (from Crises and Depression by Theodore Burton)
- “An increase in prices, first, of special commodities, then, in a less degree, of commodities generally, and later of real estate, both improved and unimproved.”
- “Increased activity of established enterprises, and the formation of many new ones, especially those which provide for increased production or improved methods, such as factories and furnaces, railways and ships, all requiring the change of circulating to fixed capital.”
- “An active demand for loans at slightly higher rates of interest.”
- “The general employment of labor at increasing or well-sustained wages.”
- “Increasing extravagance in private and public expenditure.”
- “The development of a mania for speculation, attended by dishonest methods in business and the gullibility of many investors.”
- “Lastly, a great expansion of discounts and loans, and a resulting rise in the rate of interest; also a material increase in wages, attended by frequent strikes and by difficulty in obtaining a sufficient number of laborers to meet the demand.”
- “The investor should look well, always, to the factor of safety. Before he puts his money into any road, no matter if it be on the recommendation of the greatest banker in the United States, let him consider how far that company is prepared to weather a storm.”
- “The high degree of stability imparted to interest payments and dividends by a low percentage of fixed charges, and the high degree of instability imparted by a large percentage is so elementary that it would seem to need no emphasis. And yet this item is habitually disregarded by perhaps 90% of bond and stock buyers.”
- Scalping
- “The desire to scalp is helped by impatience and greed. The small trader will grow disgusted if there is the slightest delay. Dullness is unbearable to him. Also, he will frequently close good commitments merely for the sake of ‘seeing the money.'”
- “I know of but two men who have made any considerable amount of money by scalping methods. They are exceptionally fitted for this form of trading and have the ability to take a small loss quickly. This is a trait which is very rare among public traders. A man will usually accept a small profit for no other reason than that it is a profit, and will sit stubbornly on a loss for no other reason than that it is a loss.”
- “The man who has reason to believe that a stock will advance or decline ten points, will, in nine cases out of ten, realize more profit by merely making his trade in the stock and going about his business until he considers it wise to terminate the contract. I will say decidedly that more traders will do better, make more money, and suffer less loss of time, and less annoyance by abandoning scalping tactics altogether.”
- “If the active participant is easily moved from his position by changes of a point or two against him; if he is easily frightened by wild rumors and inspired talk; if he expects to gain thousands in a few days by venturing hundreds; or if he believes that he can operate in stocks so shrewdly as to guess high or low points within a dollar or two a share, he will meet with disappointment and loss. If he can overcome these drawbacks, he may do very well as an active trader, but I wish to reiterate my views that the man who takes a position on the market and retains it, will make more money than the scalper.”
- “The mistakes made, in nine cases out of ten, have been the purchase of “cheap” securities. The hope of realizing a little more than ordinary interest, by buying paper at a discount, has proved to be the rock on which unnumbered capitalists have split. In addition to their money’s worth, they have endeavored to get something for nothing, with the result of most generally getting nothing for something. It is remarkable how blind are people, ordinarily sagacious enough to make money, to the fact that property cannot pay a revenue beyond its producing capacity.”
- “All speculators, and most investors, possess a general idea of the range and trend of prices for a considerable period. This knowledge is more frequently based upon impressions gained during their own years of activity in the speculative world than upon research. The knowledge gained by active participation is certainly the most forcible and lasting but is frequently productive of erroneous ideas.”
- “The ordinary speculator who pursues his operations for ten or fifteen points successfully is almost certain to believe that much more profit lies before him, that he is only getting started. There is a reason for this; the public trader takes for his barometer some security which has been conspicuous for its extended fluctuations; he naturally notices and remembers it to the exclusion of the rank and file of stocks.”
- “The speculator unconsciously magnifies everything connected with speculation.”
- “When a given commodity goes beyond a price where it can be replaced by another commodity, it has gone too far; and when necessities become luxuries, they take their places as such, and demand slackens.”
- “Regardless of all temporary or artificial influences, some powerful force, not related to supply and demand, is shouldering prices steadily upward… That such a force is at work is written large between the lines of compiled statistics; to ignore its existence is an error rank with mischief. The speculator who does not consult this influence may easily make the mistake of selling at low prices because they are high by comparison with prices which obtained a few years ago.”
- “The scale order is, or should be, based on the assumption that a temporary decline below the first purchase price is desirable and is necessary to the best results. This fact, however, should never be contorted in such a manner as to instigate purchases at high prices. If the operator who employs the scale order will try to make the first purchase at what he considers a bargain price, or in other words at what he calculates to be the very bottom of a movement, he will surely find that in nine cases out of ten, his own errors or the velocity which frequently carries prices to ridiculously low or high points will enable him to accumulate his line to advantage. The scale order should never be used on its mechanical merits alone, but merely as a method of averaging.”
- “It is frequently the case, particularly after a comprehensive decline or a panic, that certain excellent shares have suffered almost as much as the more questionable securities. At such times, what we want is not only a good bargain but the best bargain obtainable, and this may be secured more readily by a careful comparison of prices, values and income return than by any other method.”
- “At times the very best stock will suffer severely and much pessimistic talk will be heard of receiverships, etc. That is the time to buy.”
- “Lord Rothschild once advised a friend to buy French rentes. “But the streets of Paris are running with blood,” replied the recipient of the advice. “That,” responded Rothschild, “is the reason you can buy rentes so cheaply.””
- “It is useless to undertake to establish even a rough rule for ordinary movements by a system of averages culled from history. We find that in the course of ten years the rallies and reactions which appeared were so varied in character both as to the extent in points and the duration in days, that a barometrical average founded on such investigation would be empirical.”
- Market Cycles
- Bull Market 1897 to 1899 — Began April 1897 to April 1899. Industrials advanced about 100, Rails rose 80%.
- Bear Market 1899 to 1900 — Began May 1, 1899 to Sept. 24, 1900. Lasted 17 months. Industrials declined 32%, Rails dropped 18%.
- Bull Market 1901 to 1902 — Began Oct. 1, 1900 to Aug. 26, 1901. Lasted 11 months. Industrials rose 39%, Rails 51%.
- Bear Market 1903 — Began Jan. 8 to Nov. 9 1903. Lasted 10 months. Industrials dropped 36.5%, Rails fell 27%.
- Bull Market 1904 to 1906 — Began Jan 6. 1904 to Jan. 22, 1906. Lasted a few days past 2 years. Industrials rose 119%, Rails 55%.
- “It is necessary to study and understand the subject thoroughly, to know values, general conditions, the technical position of shares, and above all things to consult future probabilities rather than past performances. Study of the past has its educational value and this is also true of the present, but the future is the all-important thing. Retrospective speculation is one of the commonest and most flagrant of the numerous errors made by public participants. Get whatever of experience and information you can from history, but speculate on the future.”
- “The man who enters the market with insufficient capital, who expects to get rich quick or who allows success to lead him into excesses and over-speculation will lose. It is as certain as death. He may succeed for a time but not for long.”
- “Operations based on “tips” or “charts” will lead to final disaster. This thing of trying to attribute habits to a market is, in the writer’s opinion, ridiculous… Even if the market did have habits, as soon as these habits were recognized and followed by a sufficient number of people, the technical position would be rendered so rotten that the charts would fail from that influence alone.”
- “Errors on the side of prudence are vastly preferable to errors on the side of rashness. In this as in all other things, the golden mean is the really desirable factor.”
- “As to the best side of the market for operations, it is thought that the long side offers the greatest opportunities. The long side is healthier, it is constructive, and almost all the great fortunes made in the market have been founded on discreet and well-timed purchases. To adhere to this plan, however, frequently requires long periods of non-participation, and speculators are not, as a class, very patient. The man who can so school himself as to await opportunities to purchase good securities at low prices has by far the best of the bargain. Few men can do it.”
- “If the advice here given is heeded, i. e., to know what you are buying and why; to buy only good properties when prices are depressed; to exercise patience and provide sufficient capital; to eliminate first and forever the idea that correct deductions mean sudden riches; to use brains instead of charts, and common sense instead of tips; in short, to apply to speculative ventures the same degree of business foresight and understanding as would be employed in any other business, the evils and losses which have always been a part of speculative history, would be diminished.”