This is not saying that fundamental conditions do not at times warrant
sharp declines in prices and at other times equally sharp advances.
But the panic, properly so-called, represents a decline greater than
is warranted by conditions, usually because of an excited state of the
public mind, accompanied by exhaustion of resources; while the term
“boom” is used to mean an excessive and largely speculative advance.
There are some special features connected with the panic and the boom
which are worthy of separate consideration.
It is really astonishing what a hold the fear of a possible panic has
upon the minds of many investors. The memory of the events of 1907 has
undoubtedly operated greatly to lessen the volume of speculative trade
from that time to the present (April, 1912). Panics of equal severity
have occurred only a few times in the entire history of the country,
and the possibility of such an outbreak in any one month is smaller
than the chance of loss on the average investment through the failure
of the company. Yet the specter of such a panic rises in the minds of
the inexperienced whenever they think of buying stocks.
“Yes,” the investor may say, “Reading seems to be in a very strong
position, but look where it sold in 1907—at $70 a share!”
It is sometimes assumed that the low prices in a panic are due to a
sudden spasm of fear, which comes quickly and passes away quickly.
This is not the case. In a way, the operation of the element of fear
begins when prices are near the top. Some cautious investors begin to
fear that the boom is being overdone and that a disastrous decline
must follow the excessive speculation for the rise. They sell under the
influence of this feeling.
During the ensuing decline, which may run for years, more and more
people begin to feel uneasy over business or financial conditions,
and they liquidate their holdings. This caution or fearfulness
gradually spreads, increasing and decreasing in waves, but growing a
little greater at each successive swell. The panic is not a sudden
development, but is the result of causes long accumulated.
The actual bottom prices of the panic are more likely to result from
necessity than from fear. Those investors who could be frightened out
of their holdings are likely to give up before the bottom is reached.
The lowest prices are usually made by sales for those whose immediate
resources are exhausted. Most of them are taken by surprise and could
raise the money necessary to carry their stocks if they had a little
time; but in the stock market, “time is the essence of the contract,”
and is the very thing that they cannot have.
The great cause of loss in times of panic is the failure of the
investor to keep enough of his capital in liquid form. He becomes “tied
up” in various undertakings so that he cannot realize quickly. He may
have abundant property, but no ready money. This condition, in turn,
results from trying to do too much—greed, haste, excessive ambition, an
oversupply of easy confidence as to the future.
It is noticeable in panic times that a period arrives when nearly every
one thinks that stocks are low enough, yet prices continue downward to
a still lower level. The result is that many investors, after thinking
that they have “loaded up” near the bottom, find that it was a false
bottom, and are finally forced to throw over their holdings on a
further decline.
This is due to the fact mentioned above, that final low prices are the
result of necessities, not of opinions. In 1907, for example, every one
of good sense knew perfectly well that stocks were selling below their
value—the trouble was that investors could not get hold of the money
with which to buy.
The moral is that low prices, after a prolonged bear period, are not
in themselves a sufficient reason for buying stocks. The key to the
situation lies in the _accumulation of liquid capital_, which is
most quickly evidenced by a rapid recovery of the excess of deposits
over loans in the New York clearing house banks (excluding the trust
companies, in which loans are more varied). This subject, however,
takes us outside our present field.
It is to a great extent because the last part of the decline in a
panic has been caused not by public opinion, or even by public fear,
but by necessity, arising from absolute exhaustion of available funds,
that the first part of the ensuing recovery takes place without any
apparent reason.
Traders say, “The panic is over, but stocks cannot go up much under
such bearish conditions as now exist.” Yet stocks can and do go up,
because they are merely regaining the natural level from which they
were depressed by “bankrupt sales,” as we would say in discussing dry
goods.
Perhaps the word “fear” has been overworked in the discussion of stock
market psychology. It is only the very few who actually sell their
stocks under the direct influence of the emotion of fear. But a feeling
of caution strong enough to induce sales, or even a fixed belief that
prices must decline, constitutes in itself a sort of modification of
fear, and has the same result so far as prices are concerned.
The effect of this fear or caution in a panic is not limited to the
selling of stocks, but is even more important in preventing purchases.
It takes far less uneasiness to cause the intending investor to delay
purchases than to precipitate actual sales by holders. For this reason,
a small quantity of stock pressed for sale in a panicky market may
cause a decline out of all proportion to its importance. The offerings
may be small, but nobody wants them.
It is this factor which accounts for the rapid recoveries which
frequently follow panics. Waiting investors are afraid to step in front
of a demoralized market, but once the turn appears, they fall over each
other to buy.
The boom is in many ways the reverse of the panic. Just as fear
keeps growing and spreading until the final crash, so confidence and
enthusiasm keep reproducing each other on a wider and wider scale until
the result is a sort of hilarity on the part of thousands of men, many
of them comparatively young and inexperienced, who have “made big
money” during the long advance in prices.
These imaginary millionaires appear in a small swarm during every
prolonged bull market, only to fall with their wings singed as soon
as prices decline. Such speculators are, to all practical intents and
purposes, irresponsible. It is their very irresponsibility which has
enabled them to make money so rapidly on advancing prices. The prudent
man gets only moderate profits in a bull market—it is the man who
trades on “shoe-string margins” who gets the biggest benefit out of the
rise.
When such mushroom fortunes have accumulated, the market may fall
temporarily into the hands of these daredevil spirits, so that
almost any recklessness is possible for the time. It is this kind of
buying which causes prices to go higher after they are already high
enough—just as they go lower in a panic after they are plainly seen to
be low enough.
When prices get above the natural level, a well-judged short interest
begins to appear. These shorts are right, but right too soon. In a
genuine bull market they are nearly always driven to cover by a
further rise, which is, from any common sense standpoint, unreasonable.
A riot of pyramided margins drives the sane and calculating short
seller temporarily to shelter.
A psychological influence of a much wider scope also operates to help
a bull market along to unreasonable heights. Such a market is usually
accompanied by rising prices in all lines of business and these rising
prices always create, in the minds of business men, the impression that
their various enterprises are more profitable than is really the case.
One reason for this false impression is found in stocks of goods on
hand. Take the wholesale grocer, for example, carrying a stock of goods
which inventories $10,000 in January, 1909. On that date Bradstreet’s
index of commodity prices stood at 8.26. In January, 1910, Bradstreet’s
index was 9.23. If the prices of the various articles included in
this stock of groceries increased in the same ratio as Bradstreet’s
list, and if the grocer had on hand exactly the same things, he would
inventory them at about $11,168 in January, 1910.
He made an additional profit of $1,168 during the year without any
effort, and probably without any calculation, on his part. But this
profit was only apparent, not real; for he could not buy any more
with the $11,168 in January, 1910, than he could have bought with the
$10,000 in January, 1909. He is deceived into supposing himself richer
than he really is, and this false idea leads to a gradual growth of
extravagance and speculation in every line of business and every walk
of life.
The secondary results of this delusion of increased wealth because of
rising prices, are even more important than the primary results. Our
grocer, for example, decides to spend this $1,168 for an automobile.
This helps the automobile business. Hundreds of similar orders induce
the automobile company to enlarge its plant. This means extensive
purchases of material and employment of labor. The increased demand
resulting from a similar condition of things in all departments of
industry produces, if other conditions are favorable, a still further
rise in prices; hence at the end of another year the grocer perhaps has
another imaginary profit, which he spends in enlarging his residence or
buying new furniture, etc.
The stock market feels the reflection of all this increased business
and higher prices. Yet the whole thing is psychological, and sooner or
later our grocer must earn and save, by hard work, economical living
and shrewd calculation, the amount he has paid for his automobile or
furniture.
Again, rising stock prices and rising commodity prices react on each
other. If the grocer, in addition to his imaginary profit of $1,168
sees a ten per cent. advance in the prices of various securities
which he holds for investment, he is encouraged to still larger
expenditures; and likewise if the capitalist notes a ten per cent.
advance in the stock market, he perhaps employs additional servants and
enlarges his household expenditures so that he buys more groceries.
Thus the feeling of confidence and enthusiasm spreads wider and wider
like ripples from a stone dropped into a pond. And all of these
developments are faithfully reflected by the stock market barometer.
The result is that, in a year like 1902 or 1906, the high prices
for stocks and the feverish activity of general trade are based, to
an entirely unsuspected extent, on a sort of pyramid of mistaken
impressions, most of which may be traced, directly or indirectly, to
the fact that we measure everything in money and always think of this
money-measure as fixed and unchangeable, while in reality our money
fluctuates in value just like iron, potatoes, or “Fruit of the Loom.”
We are accustomed to figuring the money-value of wheat, but we get a
headache when we try to reckon the wheat-value of money.
When a fictitious situation like this begins to go to pieces, the
stock market, fulfilling its function of barometer, declines first,
while general business continues active. Then the “money sharks of
Wall Street” get themselves roundly cursed by the public and there is
a widespread desire to wipe them off the earth in summary fashion.
The stock market never finds itself popular unless it is going up;
yet its going down undoubtedly does far more to promote the country’s
welfare in the long run, for it serves to temper the crash which must
eventually come in general business circles and to forewarn us of
trouble ahead so that we may prepare for it.
It is generally more difficult to distinguish the end of a stock market
boom than to decide when a panic is definitely over. The principle
of the thing is simple enough, however. It was an oversupply of
liquid capital that started the market upward after the panic was
over. Similarly it is exhaustion of liquid capital which brings the
bull movement to an end. This exhaustion is shown by higher call
money rates, loss of the excess of deposits over loans in New York
clearinghouse banks, a steady rise in commercial paper rates, and a
sagging market for high-grade bonds.
VII—The Psychology of Scale Orders
The observer of market conditions soon comes to know that there are
two general classes of minds whose operations are reflected in prices.
These classes might be named the “impulsive” and the “phlegmatic.”
The “impulsive” operator says, for example, “Conditions, both
fundamental and technical, warrant higher prices. Stocks are a
purchase.” Having formed this conclusion, he proceeds to buy. He does
not try or expect to buy at the bottom. On the contrary he is perfectly
willing to buy at the top so far, provided he sees prospects of a
further advance. When he concludes that conditions have turned bearish,
or that the advance in prices has overdiscounted previous conditions,
he sells out.
The “phlegmatic” type of investor, on the other hand, can hardly ever
be persuaded to buy on an advance. He reasons, “Prices frequently
move several points against conditions, or at least against what the
conditions seem to me to be. The sensible thing for me to do is to take
advantage of these contrary movements.”
Hence when he believes stocks should be bought he places an order to
buy on a scale. His thought is:
“It seems to me stocks should advance from these prices, but I am not
a soothsayer, and prices have often declined three points when I felt
just as bullish as I do now. So I will place orders to buy every half
point down for three points. These speculators are a crazy lot and
there is no knowing what passing breeze might strike them that would
cause a temporary decline of a few points.”
Among large capitalists, and especially in the banking community, the
“phlegmatic” type naturally predominates. Such men have neither the
time nor the disposition to watch the ticker closely and they nearly
always disclaim any ability to predict the smaller movements of prices.
They are entirely ready, nevertheless, to take advantage of these small
fluctuations when they occur, and having plenty of capital, they can
easily accomplish this by buying or selling on a scale.
As a matter of fact, the market is usually full of scale orders, and
the knowledge of this and of the way in which such orders are handled
is decidedly helpful in judging the tone and technical position of the
market from day to day.
The two types of operators above described are always working against
each other. The buying or selling of the “impulsive” trader tends to
force prices up or down, while the scale orders of the “phlegmatic”
class tend to oppose any movement.
For example, let us suppose that banking interests believe conditions
to be fundamentally sound and that the general trend of the market
will be upward for some time to come. Orders are therefore placed by
various persons to buy stocks every point down, or every half, quarter,
or even eighth point down.
On the other hand, the active floor traders find that, owing to some
temporary unfavorable development, a following can be obtained on the
bear side. They perceive the presence of scale orders, but they think
stocks enough will come out on the decline to fill the scale orders and
leave a balance over.
To put it another way, the floating supply of stocks has become, at
the moment, larger than can comfortably be tossed about from hand to
hand by the in-and-out class of traders. The market must decline until
a part of this floating supply is absorbed by the scale orders which
underlie current prices.
These conditions produce what is commonly called a “reaction.” Once
this surplus floating supply of stocks is absorbed by standing orders,
the market is ready to start upward again. If the general trend is
upward, far less resistance will be encountered on the advance than
was met on the reaction; hence prices rise to a new high level. Then
profit-taking sales will be met, on limited or scale orders at various
prices, and as the market advances the floating supply will gradually
increase until it again becomes unwieldy and another reaction is
necessary.
Eventually a level is reached, or some change in conditions appears,
which causes these scale buying orders to be partially or entirely
withdrawn, and selling orders to be substituted on a scale up. The bull
market will not go much further after this change takes place. It has
now become easier to produce declines than advances. The situation is
the reverse of that described above, and a bear market follows.
Commonly there is a considerable period around top prices when scale
buying orders are still found on declines, but profit-taking sales are
also met on advances, so that the market is kept fluctuating within
comparatively narrow limits for a month or more. In fact, it is likely
to be kept on this level so long as public buying continues greater
than public selling. This is sometimes called “distribution.” A similar
period of “accumulation” often occurs after a bear market has run its
course, and before any important advance appears.
A close watch of transactions, or a study of continuous quotations as
published in certain newspapers, often enables the experienced trader
to discover when the most important of these scale orders are withdrawn
or reversed.
A bull market which is full of scale buying orders encounters
“support,” so-called, on declines. Bears are timid about driving down
prices, because they are continually “losing their stocks.” They say
that “very little stock comes out on declines”; hence there is a
certain appearance of caution in the way the market goes down, and
the activity of trade shows, in a broad way, a falling off at lower
prices. On the advances, however, a following is obtained and activity
increases.
Toward the end of the bull market a change is noticeable. Prices go
down easily and on larger transactions, while advances are sluggish and
opposition is met at higher levels where profit-taking orders have been
placed. The very day when scale buying orders in a stock are withdrawn
can oftentimes be distinguished.
In a bear market, “pressure” appears in place of “support.” The scale
orders are mostly to sell as the market rises. Only a small following
of purchasers is obtainable on advances, hence the activity of
business, in a general way, falls off as prices go up. The end of the
bear market is marked by the reappearance of “support” and the removal
of “pressure,” so that prices rebound quickly and sharply from declines.
The common assumption is that this “support” or “pressure” is supplied
by “manipulators.” But it is quite as likely to result from the scale
operations of hundreds of different persons, whose mental make-up
prevents them from buying or selling in the “impulsive” way.
VIII—The Mental Attitude of the Individual
In previous chapters we have seen that many, if not most, of
the eccentricities of speculative markets, commonly charged to
manipulation, are in fact due to the peculiar psychological conditions
which surround such markets. Especially, and more than all else
together, these erratic fluctuations are the result of the efforts
of traders to operate, not on the basis of facts, nor on their own
judgment as to the effect of facts on prices, but on what they believe
will be the probable effect of facts or rumors on the minds of other
traders. This mental attitude opens up a broad field of conjecture,
which is not limited by any definite boundaries of fact or common sense.
Yet it would be foolish to assert that assuming a position in the
market based on what others will do is a wrong attitude. It is
confusing to the uninitiated, and first efforts to work on such a plan
are almost certain to be disastrous; but for the experienced it becomes
a successful, though of course never a certain, method. A child’s first
efforts to use a sharp tool are likely to result in bloodshed, but the
same tool may trace an exquisite carving in the hands of an expert.
What, then, should be the mental attitude of the intelligent buyer and
seller of securities?
The “long pull” investor, buying outright for cash and holding for a
liberal profit, need only consider this matter enough to guard against
becoming confused by the vagaries of public sentiment or by his own
inverted reasoning processes. He will get the best results by keeping
his eye single to two things: Facts and Prices. The current rate of
interest, the earning power of the corporations whose stocks he buys,
the development of political conditions as affecting invested capital,
and the relation of current prices to the situation as shown by these
three factors—these constitute the most important food for his mind to
work upon.
When he finds himself wandering off into a consideration of what “They”
will do next, or what effect such and such events may have on the
sentiment of speculators, he cannot do better than to bring himself up
with a short turn and sternly bid himself “Back to common sense.”
For the more active trader the situation is different. He need not be
entirely unregardful of values or fundamental conditions, but his prime
object is to “go with the tide.” That means basing his operations to a
great extent on what others will think and do. His own mental attitude,
then, is a most important part of his equipment for success.
First, the trader must be a _reasoning optimist_. A more horrible fate
can scarcely be imagined than the shallow pessimism of many market
habitués, whose minds, incapable of grasping the larger forces beneath
the movements of prices, take refuge in a cynical disbelief in pretty
much everything that makes life worth living.
Owing to the nature of the business, however, this optimism must be of
a somewhat different character from that which brings success in other
lines. As a general thing optimism includes the persistent nourishing
of hope, an aggressive confidence, the certainty that you are right,
a firm determination to accomplish your end. But you cannot make the
stock market move your way by believing that it will do so. Here is one
case, at any rate, where New Thought methods cannot be directly applied.
In the market you are nothing but a chip on the tide of events.
Optimism, then, must consist in believing, not that the tide will
continually flow your way, but that you will succeed in floating with
the tide. Your optimism must be, in a sense, of the intellect, not of
the will. An optimism based on determination would, in this case,
amount to stubbornness.
Another quality that makes for success in nearly every line of business
is enthusiasm. For this you have absolutely no use in the stock
market. The moment you permit yourself to become enthusiastic, you are
subordinating your reasoning powers to your beliefs or desires.
Enthusiasm helps you influence other men’s minds, but in the market you
do not desire to do this (unless you happen to be a big bull leader).
You wish to keep your mind as clear, cool and unruffled as the surface
of a mountain lake on a calm day. Any emotion—enthusiasm, fear, anger,
depression—will only cloud the intellect.
Doubtless it would be axiomatic to warn the trader against
stubbornness. It cannot be assumed that any operator would consciously
permit himself to become stubborn. The trouble arises in drawing the
line between, on the one hand, persistence, consistence, pursuit of
a definite plan until conditions change; and, on the other, stubborn
adherence to a course of action which subsequent events have proved to
be erroneous.
A day in the country, with the market forgotten, or if necessary
forcibly ejected from the thoughts, will often enable the trader to
return with a clarified mind, so that he can then intelligently convict
or acquit himself of the vice of stubbornness. Sometimes it may become
necessary to close all commitments and remain out of the market for a
few days.