Ben Graham once alluded to the idea that the market cycle might as well be called the human-nature cycle. Because the rise and fall of speculative behavior follow the same path.
Graham, of course, meant it as a warning.
He saw speculation as an attempt to profit purely off of moves in market prices. Nothing else matters. Not valuation, earnings, cash flows, or what management is doing to improve the business. Just price.
In other words, if you’re buying a stock with the hope of flipping it to someone else at a higher price, then you’re speculating.
The keyword being hope. When you buy a stock for no reason other than you believe the price is going up, you’re going to need it. You might as well be gambling. Decisions based on price alone are almost always emotional and emotions ruin returns.
The worst part is that every bull market offers the illusion that money can be easily made. So, people always bite. And because years go by between bull markets, not enough people remember how the last speculative period ended.
With that said, there is such a thing as “intelligent speculation.” Graham mentioned it briefly in The Intelligent Investor and expanded on it in some lectures. It requires playing a role similar to a casino or oddsmaker, not the gambler.
Unfortunately, most speculators never think that far ahead. They have no strategy. They don’t consider probabilities. They overconcentrate in all-in bets. They refuse to let go of losing bets in the hopes of breaking even.
They lose for the reasons gamblers always lose to the House. Overconfidence, overoptimism, misunderstanding odds, and misconstruing luck for skill are symptoms of the problem.
As Ed Thorp once said:
Gambling is a tax on ignorance. People often gamble because they think they can win, they’re lucky, they have hunches, that sort of thing, whereas in fact, they’re going to be remorselessly ground down over time. — Source
It devolves into desperation. Betting money earmarked for retirement or college on some longshot because its price went up, hoping it repeats its performance, is exactly as stupid as it sounds. Yet it happens. Too often. When the latest round of day trading dies out, those ruinous stories emerge.
This is why the greats, like Ben Graham, always warn about speculating in markets.
The chief hazard of a careful common stock program is not that it may bring unexpected losses, but that its profits will turn the investor into a speculator greedy for quicker and bigger gains — and therefore headed for ultimate disaster. — Source
Of course, he wasn’t alone.
Tradition, sentiment, vague generalizations, unsubstantiated rumors, can never be made the basis of sound investment or intelligent speculation. Now and then large profits are realized on no better foundation — merely proving that sometimes luck laughs at logic. — Ben Graham
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The chief evils of speculation flow from the participation of the general public, who lack the special knowledge, and enter the market in a purely gambling spirit. — Irving Fisher
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The line I draw in the sand is that if an asset has cash flow or the likelihood of cash flow in the near term and is not purely dependent on what a future buyer might pay, then it’s an investment. If an asset’s value is totally dependent on the amount a future buyer might pay, then its purchase is speculation. — Seth Klarman
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We live in an investment world, populated not by those who must be logically persuaded to believe, but by the hopeful, credulous and greedy, grasping for an excuse to believe. — Warren Buffett
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It is a great mistake to believe that a speculation has been unwise if you lose money at it. That sounds like an obvious conclusion, but actually it is not true at all. A speculation is unwise only if it is made on insufficient study and by poor judgment. I recall to those of you who are bridge players the emphasis that the bridge experts place on playing a hand right rather than on playing it successfully. Because, as you know, if you play it right you are going to make money and if you play it wrong you lose money — in the long run. — Ben Graham
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The game of professional investment is intolerably boring and overexacting to anyone who is entirely exempt from the gambling instinct; whilst he who has it must pay to this propensity the appropriate toll. — John Maynard Keynes
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Almost any asset can be risky or safe, depending on how other investors treat it. — Howard Marks
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Individual investors tend to churn their accounts, they tend to trade too much, and that they trade too much seems to be due to over-confidence. They believe they know something that they do not know and this is one essential characteristic of human beings, which makes them different from rational beings. — Daniel Kahneman
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To lose money is the conventional penalty for bad judgment in speculation. — Philip Carret
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When the wave of speculative madness receded in 1929, it left so many corpses on the beach that most people thought only of the victims and forgot the beneficiaries. The brokers never make the money that speculators lose. That money goes to the non-speculators, to investors, to the people who alone buy securities in bear markets. Think a little and you will realize that the chief economic function of the speculator class is to feed the investor class. — Edwin Lefevre
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People without experience or superior ability may make a lot of money fast in the stock market, but they cannot keep what they make, and most of them will end up as net losers. — Ben Graham
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Having a long term strategy may seem a quaint idea in a market dominated by high frequency trading, the 24 hour news cycle, the ubiquitous and shrill blogosphere, flash crashes, and where it is repeated as though divinely given that buy and hold is dead. — Bill Miller
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Any time you offer a big prize for a small amount of money, you encourage stupid behavior on behalf of those you’re appealing to. — Warren Buffett
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Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. — John Maynard Keynes
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If the relative stability of general business and corporate profits produces an unlimited enthusiasm and demand for common stocks, then it must eventually produce instability in stock prices. — Ben Graham
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The first task of the bargain hunter is to narrow the field and separate the solid prospects from the ones that are counting on hopes, prayers, and miracles. — Peter Lynch
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What makes the game of stock speculation the most dangerous of all is the variety of pleasing disguises it is able to assume. Being born of greed, it feeds on greed and thereby waxes greater. If that were all it did, or if it did this openly, it would not be so dangerous; but besides the additional lure of adventure there is the irresistible appeal to vanity, the challenge to pit your wits against other wits, and even against Nature and the vagaries of the weather and the weaknesses of men. It most often masquerades as a legitimate business operation, subject to and governed by the ordinary rules of ordinary business. Of course, one reason for this is that the buying and selling of stocks do not necessarily constitute gambling. The buying or selling of stocks on margin in expectation of immediate and large profits is probably gambling and nothing else, whether or not you have a scientific system that cannot fail. – Edwin Lefevre
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Speculation is a loser’s game. Because of the costs, it has to be a loser’s game. — John Bogle
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When stocks are rising for no better reason than that they have risen, the greater fool is at work. — Seth Klarman
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Allied to the general pattern of market movements is the general pattern of speculative thinking. — Ben Graham
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It makes no sense for individual investors to jump in and out of the market. People who trade in that way rarely die rich, whereas the patient investor often does. — Philip Carret
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When people think there’s easy money available, they’re not inclined to change. — Warren Buffett
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The trouble with the game of stock speculation is that, strictly speaking, it is not a hazard in which the element of chance can be figured out with mathematical exactitude… Moreover, the line of demarcation between investment and what you might call intelligent speculation is not clearly indicated to the average mind. The stock speculator, as a rule, is beaten by himself! The reason why the speculator is beats himself is to be found in his motives quite as much as in the inherent difficulty of guessing accurately. — Edwin Lefevre
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Market timing is speculating and it rarely, if ever, pays off. — Peter Lynch
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Speculators often prosper through ignorance; it is a cliche that in a roaring bull market knowledge is superfluous and experience a handicap. But the typical experience of the speculator is one of temporary profit and ultimate loss. — Ben Graham
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I think I am safe in asserting that the margin trader, speculator, gambler, or whatever you choose to designate the average man who goes to Wall Street after easy money, does not lose money when he sells. He loses it when he buys! — Edwin Lefevre
This post had been updated; originally published on June 4, 2021.
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