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 the price is going up, you’re gonna need it. You might as well be gambling.
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.
Decisions based on price alone are almost always emotional and emotions ruin returns.
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, is exactly as stupid as it sounds. Yet, it happens. Too often. When the latest round of day trading dies out, those ruinous stories will 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.
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
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
The typical experience of the speculator is one of temporary profit and ultimate loss. — Ben Graham
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
Almost any asset can be risky or safe, depending on how other investors treat it. — Howard Marks
To lose money is the conventional penalty for bad judgment in speculation. — Philip Carret
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
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
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
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
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
Speculation is a loser’s game. Because of the costs, it has to be a loser’s game. — John Bogle
When stocks are rising for no better reason than that they have risen, the greater fool is at work. — Seth Klarman
Allied to the general pattern of market movements is the general pattern of speculative thinking. — Ben Graham
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
When people think there’s easy money available, they’re not inclined to change. — Warren Buffett
Market timing is speculating and it rarely, if ever, pays off. — Peter Lynch
Speculators often prosper through ignorance. — Ben Graham
- You Don’t Need Alpha – Of Dollars and Data
- Does A Mutual Fund’s Past Performance Predict Its Future? – Yale Insights
- How to Measure Value These Days – Klement on Investing
- Stranger Things – Verdad
- The Ugly Scramble – M. Housel
- Thinking For Oneself – Farnam Street
- Cliff Asness: “But Not So Open You Mind Falls Out” (podcast) – Flirting with Models
- The Greatest Business Deal In Sports History – Huddle Up
- How to Outrun a Dinosaur – Wired