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THE THEORY
OF
STOCK EXCHANGE
SPECULATION.
BY
ARTHUR CRUMP.
With Preface and Annotations by
H. W. ROSENBAUM.
NEW YORK:
H. W. ROSENBAUM.
1887.
COPYRIGHT, 1886.
BY H. W. ROSENBAUM.
JONES PRINTING CO. PRESS,
47 Broad St., New York.
PREFACE.
Some years ago I came across a book, called “Crump’s Theory of Stock
Speculation,” which had gone through several editions in England; and the
practical wisdom expressed therein impressed me so forcibly that ever
since then I formed the project of publishing an American edition.
The reader may be astonished that, as a broker, I desire to give such a
book a larger circulation than it possessed heretofore, as the natural
conclusion would be that it might injure my business. I feel, however,
that it is not so, and think that a broker loses nothing by doing his
duty in warning his clients against danger, and showing them the pitfalls.
I do not quite agree with the author of the book on every point,
especially when he seeks to convey the impression that it would seem
almost impossible that any profit could be derived from Stock Exchange
speculation. During my long experience I have seen many speculators
accumulate large fortunes, and I believe that when speculation is
conducted by a clear-headed man, as a matter of business and not as a
matter of amusement, it offers great chances.
Where the strength of Mr. Crump’s work lies is in his showing what
attributes of character a man must possess to be successful, and with
these attributes a man must prove successful in stock speculation as well
as in any other business. Condensed, these attributes are: first, a clear
head; second, capital; and third, patience.
I do not agree with Mr. Crump, that a speculator, to be successful,
must be a hard-hearted, selfish man. I found it different with most of
the prominent men in Wall Street. Of course, if a Gould or a Vanderbilt
buys up a whole railroad, he cannot very well take many people into
his confidence; but these men are not what is generally called
speculators—they are generals or diplomats, and they are not different in
their actions from generals in warfare or diplomats in politics.
Outside of this class, I found generally, when I asked one of the
prominent speculators for his opinion of the market, that he gave
me his true and candid opinion of the future of the market; and the
probabilities are that, if even not acting on this opinion at that very
moment, his general policy was based on such a forecast of the market’s
condition.
The strength of the successful speculator lies in his observing the
important principle set forth by Mr. Crump on page 60 of his work.
“Speculators never set sufficient value on the importance of avoiding a
loss—they think only of the profits.” As it is with our money affairs
when we say, “_Look after the pence; the pounds will take care of
themselves_,” so it is with speculation. Look after the losses; the
profits will take care of themselves. Never refuse a profit, is a golden
motto for speculators, which unhappily few of them, in their greediness,
have the courage to adopt. The observance of this rule is the main cause
of the success of the best speculators, and the non-observance is the
cause of failure of even their confidential friends.
Very few fortunes have been made in Wall Street at one stroke. Fortunes
which were made in that way were generally lost again in a very short
time. Most of the long, lasting, and solid fortunes were made by a
gradual accumulation of profits extending over a great many years. The
beginnings of these were sometimes quite small, and, as the capital
increased, larger operations were entered into.[1]
Another cause of failure is the habit of taking larger risks than the
means of speculators warrant. They naturally become nervous when they
begin to see their capital dwindle away, and then begin, what is called
in Wall Street, to “chip out.” Now this is the curse of the speculator,
not so much on account of the loss, as on account of the demoralization
it will lead him into. Of course, big losses ought to be avoided, but
at the same time well based and matured operations may sometimes be
temporarily upset by a temporary manipulation of the market, or by some
accidents which however right themselves in a few days, and cannot
seriously interrupt the natural course of the market. In such a market a
nervous speculator may “chip out” a fortune, and still be right in his
views as to general conditions.
I think it is better to make one loss of 5 per cent. or so, when you
know you are wrong, than to make three or five losses of 1 per cent.
each, when you do not know whether you are wrong or right, and in this
connection Mr. Crump has very much undervalued the importance of options.
Options, if considered in their proper light, are the most important
adjunct to speculation. They will enable the speculator to bridge over
many difficulties, and furnish capital to speculators who know how to use
them.
I do not say this simply because I am a broker in options, but because
it is my honest conviction that options are cheap at almost any price,
when a speculator has occasion to use them. If money is lost by buyers
of options, it is because many of them are bought by people who have not
sufficient reasons for doing so, and after the option has been bought,
the owner does not know what to do with it. I have, for example, known
people to be bulls on Lake Shore, and then go and spend money for a put
in Western Union. Is it any wonder that men who do business on such
principles lose money?
That many stock brokers object to options is natural. They look out for
commissions, and greatly prefer to buy and sell several times a day on
stop orders or on margins, even if customers lose money thereby, rather
than see them make money two or three times a year, through operations
extended over periods of two or three months each.
I do not mean to say that all stock brokers are of this kind, but
if speculators recall their own experience, they will undoubtedly
remember how often their broker said to them, “Cut your losses,” if the
transaction was against them, while, if the transaction showed a profit,
the advice was, “Taking profits will never make any man poorer.” All
these things make commissions for the broker, and this is the object of
his business.
Another reason for the unwillingness of some brokerage houses to
encourage speculation against options must be found in the fact that a
great many of them have not sufficiently large capital to enter upon
large transactions without any other margin than the option. Although I
acknowledge that it is hardly fair to ask a broker to do an unlimited
amount of business based on options alone, the fact, nevertheless, exists
that the strongest houses have always been glad to encourage trading
against options, and only the more insignificant houses are opposed to it.
A well planned and matured operation, looking far ahead, backed by ample
capital and patience, is the only way to make a fortune at the Stock
Exchange, and prudence demands that in case the speculator’s idea should
have been wrong, he should have a safe way for a retreat open. Options
will fulfill all these demands; and no matter how expensive, if the
speculator can afford it, it is the only way of speculating in a safe and
reasonable manner.
There are some people who are under the impression that they know
everything already, and have nothing to learn, and such may be amused,
but not benefited, by reading this book; others, however, who are
inclined to speculate (and there are and always will be many of them)
cannot fail to derive great benefit from the perusal of Mr. Crump’s
interesting work, and I hope I may put money in some people’s pockets
or save others from ruin by sending this book forth among the American
people.
H. W. ROSENBAUM.
NEW YORK, NOV., 1886.
The last chapter in Mr. Crump’s book, entitled “Outside Criticism on the
Causes of Disturbance in the Money Market,” has been omitted in this
edition, as it relates simply to questions about the policy of the Bank
of England in regard to regulating the discount rate, and a controversy
and correspondence on this point between Mr. Crump and Mr. Bonamy Price.
As this whole question is of no practical value or interest to the
American reader, I thought it expedient to omit the whole matter.
H. W. R.
CONTENTS.
PAGE
CHAPTER I.
_Technical Terms Explained._
1. Jobbers and Brokers 19
2. The Bull 19
3. The Bear 19
4. Contango 20
5. Backwardation 24
6. Options 26
7. The “Put and Call” Option 26
8. The “Put” Option 26
9. The “Call” Option 26
10. The Fortnightly Settlement 27
11. Speculation by Members of the House 28
CHAPTER II.
_The Importance of Special Knowledge regarding the Regularly
Recurring Causes that influence the Markets._
1. The Temper of the Public 32
2. Meteorological Influences 32
3. A Favorable Period of the Year 35
4. Causes affecting the Value of English Railway Stocks 36
5. The Course to pursue at the Turn of the Half-year 36
6. Second Half of the Year more favorable for Bear Operations 37
7. Activity among Buyers 39
8. The Bull Speculator’s Great Chance 39
9. The great importance of being now and again altogether
Clear of the Markets 40
10. The Movement of Prices near the Settlements 41
CHAPTER III.
_The Right Temperament for a Professional Speculator._
1. Cool-headedness an indispensable Condition of Success 43
2. The Uselessness of Haphazard Speculation 45
3. Accurate Foresight 45
4. The Cool Man, or Professional Speculator 46
5. Observance of the daily published Telegrams from abroad 46
6. The Selfishness and Hard-heartedness of the Professional
Speculator 48
7. The Non-professional or Haphazard Speculator 50
8. The Misfortune of Early Gains 55
9. Very few Failures made Public 57
10. Greediness involves Loss 60
11. Keeping one’s own Counsel 60
CHAPTER IV.
_The Increase of Speculation in Stocks and Shares._
1. Stock Exchange Gambling increases in Europe, while Public
Gaming-Houses are on the decline 62
2. Speculation an Out-growth of prosperous times 63
3. Commercial prosperity unhealthily fostered by Illegitimate
Speculation 64
4. The Influence of Trade Profits upon the Stock Markets 64
5. An increase in the amount of Trade Profits realized, causes
an Increase in the number of Securities 65
6. Speculation by Established Companies 66
7. The Demoralization caused by Temporary Success 66
8. The New Era in Speculation 67
9. Collapse through Over-speculation in Austria 67
10. Increase in the number of Members of the London Stock
Exchange 68
CHAPTER V.
_Modern Influences upon the Markets._
1. A Fixed Line of Action 71
2. Closer Uniformity of Values in all Markets through the
Development of the Telegraph System 72
3. A speculator cannot hope to succeed in any degree, unless
his arrangements are as complete as those of a man
engaged in _bona fide_ business 73
4. The Diminution of Gluts in all Markets 73
5. Modern conditions render it more difficult than formerly
for Small Mercantile Houses to succeed 73
6. Every Commercial Revulsion destroys Houses of a Speculative
character, and throws the good business into the
hands of the large sound Establishments 75
7. The Extension of Long-wire Telegraphy 78
8. Money Famines should henceforth be as improbable of
occurrence as Corn Famines 78
9. Advantages derived from opening up communications with
the Corn-growing Provinces of Russia 80
10. The Growth of Wealthy Monetary Centres 82
11. Private Cipher Telegrams as exterior influences upon Prices 83
12. The Altered Character of interior influences upon Prices 84
13. The Creation of Securities to meet the Demand 84
14. Getting behind the Scenes 85
15. The Difficulty of “Cutting” a Loss 85
CHAPTER VI.
_Cacoëthes Operandi._
1. Waiting for Extremes 87
2. Reaction generally more rapid after a Sharp Rise 88
3. What Not To Do 90
4. Special Information 90
5. Much Money only obtainable as a certainty by Hard Work 90
6. An Average Instance of Haphazard Speculation 91
CHAPTER VII.
_The Pit-falls._
1. Hidden Forces Opposed to the Speculator 94
2. The Turn 95
3. The Danger of taking Advice 95
4. A Disinterested Opinion 96
5. All the Eggs in One Basket 96
6. Traps for the Public 97
7. The Public as Speculators are Bulls by Nature 97
8. A Case of Roasting the Bulls 98
9. A Cut off the Loaf and Pass it on 98
10. Short Periods in, and Long ones out 99
CHAPTER VIII.
_Speculation With Capital._
1. Restoring the Balance of Advantages 100
2. The Necessity of Some Capital 101
3. Capital to expend in Feints 102
4. La haute Finance 102
5. The Best of all Chances for a Speculator with Capital 103
6. The most Legitimate Form of Speculation, Pawning the Stock 104
7. When to Begin and when to Leave Off 105
8. Test of a Speculator’s Pecuniary Position 105
CHAPTER IX.
_Speculation Without Capital._
1. A Familiar Case 107
2. Bitter Experience 108
3. The Question of Seeing it Out 108
CHAPTER X.
_The “Tip” to Buy or Sell._
1. A Friendly “Tip” 110
2. Unloading at other People’s Expense 111
3. The Qualified “Tip” 111
4. The Unqualified “Tip” 112
5. “Tips” worked by Syndicates 112
CHAPTER XI.
_Speculation by Machinery._
1. Machinery in existence for directing Human Volition 114
2. The Patrician Investor 115
3. Administering Shares to the Public 116
CHAPTER XII.
_The Shifting of Speculation from the Higher to the Lower
Classes of Securities._
1. Speculation in Consols as a Hedge 120
2. Speculation has Changed its Venue 121
3. Increase of the Indebtedness of the States of the World 121
4. The Fluctuations in the Price of Government Stocks 121
5. High Class Stocks more firmly held than formerly 122
CHAPTER XIII.
_The Short “Turns,” or who makes the Profits?_
1. The “Turn,” a known quantity always against the Speculator 124
2. The “Turn,” a Loss in going into, and also in coming out
of the Market 125
3. The difference in the character of the “Turn,” as compared
with former times 125
4. Special Danger of Speculating in a Stock that is quoted
very wide 127
5. The “Turn,” the Income of the Jobber 128
CHAPTER XIV.
_In what respect is Speculation useful in Markets generally?_
1. Speculation for the Rise, which is both Legitimate and of
Benefit to the Community 129
2. Speculation for the Fall, which is both Legitimate and of
Benefit to the Community 130
3. A Reasonable Relative Value for all Commodities 131
4. The Three Classes into which Speculators may be divided 132
INTRODUCTION.
Our object in writing this book is to endeavour to show to persons who
may contemplate trying their hand at Stock Exchange speculation, the
improbability of their hopes being realized. Much mischief and trouble
would be avoided, and a deal of money saved, if, before entering upon
such a dangerous career under the most favorable circumstances as that of
a speculator, a study were made of the difficulties such an occupation
involves, and also of the chances against the operator, considered as
one individual _versus_ the Stock markets. It is melancholy to think
of the vast sums of money that are invested in the most serious sense
of the word, annually by Stock Exchange speculators in the purchase of
a sorrowful experience. It seems to be in the nature of things, that
numbers of people must come to grief in their early struggles, through an
obstinate determination to trust complacently in their own ingenuity, in
preference to profiting by the experience of others. A mountain climber
who disclaims the aid of a guide, and is subsequently fished out of a
crevasse, can expect no other epitaph, even from his friends, than that
he has paid the deserved penalty of extreme temerity and folly. There are
probably many guides who can ensure a safe passage over most mountain
defiles, but he would be a bold man who guaranteed to pilot a young
speculator through the Stock markets, and bring him out to a certainty
with a profit.
If a speculator asks the advice of what we will term “an old hand,” and
it is in his interests to tell him what he really thinks, he will say:
“Leave it alone.”
Why so many people will never be convinced except by their own personal
experience is, that they cannot believe what others say of things that
are hidden.
“Hereof experience hath informed reason, and time hath made those things
apparent which were hidden,” says Sir W. Raleigh.
“But apt the mind or fancy is to rove
Uncheck’d, and of her roving is no end,
Till warn’d, or by experience taught, she learns
That not to know at large of things remote
From use, obscure and subtle, but to know
That which before us lies in daily life
Is the prime of wisdom,”
says Milton; and
“But if you’ll prosper, mark what I advise,
Whom age and long experience render wise,”
says Pope.
Stock Exchange speculation is very deceitful to the eye, and also to
the ear. In some respects its associations are like those of a morass,
under whose smooth and inviting surface are hidden the remains of unwary
travellers. Those who are new to the business see only the glittering
surface, and hear only of the fortunes made by stock brokers. People
seldom tell of their losses.
Individuals who are tempted, not only by curiosity, but by a love of
excitement, and more than all in this case by the love of gain, go into
the markets and lose their money, and quit the place with much the same
feelings as the man who paid a penny to see a horse with his tail where
his head ought to be.
“If we hope for things of which we have not thoroughly considered the
value, our disappointment will be greater than our pleasure in the
fruition of them,” wrote Addison.
The most brilliant good fortune which may result from the operations of
a speculator generally fall below his anticipations, when the operations
are reduced to figures. It appears that the imagination gets, as it
were, diseased by feeding on the contemplation of very rapid gains; and
that whatever may be the reality of a hypothetical gain, the mind gets
bewildered and fails to estimate as an element of loss, the surrounding
husks in which the fruit is enclosed. One forgets that every tangible
advantage, in whatever form obtained in this life, has to be got out of a
shell. What, then, must be the speculator’s feelings when the balance is
on the wrong side of the account?
It has been suggested that the abolition of “time-bargains” would
materially, if not quite, prevent much of the mischief that results from
speculation; but it is no more possible entirely to do away with the
custom of “time-bargains” than it is to abolish credit in other kinds of
business. It may be readily conceded that a very large number of those
who are ruined or greatly injured by Stock Exchange speculation, would
never operate at all if they were called upon even to make a deposit
before the purchase was effected. But when it is considered that to
abolish “time-bargains” would be to ruin at once half the brokers in
existence, the difficulty of effecting what from one point of view would
be a most salutary change of custom, will be understood. In our day money
is so closely employed that a fortnight is not too long to get the funds
together, when, for some good reason or other, a change of investment
has been determined on. It is often that such a transfer gives rise to a
course of speculation that ends in disaster. A purchase effected for the
account[2] with the view of changing from one stock to another leaves at
the end of the fortnight, we will suppose, a handsome profit. The buyer
of the stock takes it, and postpones the intended change of investment,
thinking he shall get rich sooner by such an operation as that, than by
simply transferring his money to another security that promised a better
yield per cent. He has another try, expecting the same good fortune. In
the end he loses as usual on balance, which he would not probably have
done if he had bought and sold for money, finishing the operation on
the same day. This is what often causes loss to people who can afford
to lose, if they stop soon enough. The great mischief is done by the
facilities afforded by “time-bargains” to operators who have a little
money, just sufficient to enable them to keep afloat as speculators in
fair weather. The first serious disturbance that violently agitates
prices sweeps them away in a shoal.
The question which a sensible speculator will ask himself before he
begins to operate is, What are the risks incurred of losing his all at
one stroke? De Morgan, in his book on probabilities, says in Chapter V.,
on the risks of loss or gain, “A man should not hazard his all on any
terms; but in ventures the loss of one of which would not be felt, we
may suppose the venturer able to make a large number of the same kind;
in which case the common notions of mankind reinforced by the results of
theory, tell us that the sum risked must be only such a proportion of
the possible gain as the mathematical probability of gaining it is of
unity. For instance: suppose I am to receive a shilling if a die, yet
to be thrown, give an ace; in the long run, an ace will occur one time
out of six, or I shall lose five times for every time which I gain. I
must, therefore, make one gain compensate the outlay of six ventures, or
one-sixth of a shilling is what I may give for the prospect, one time
with another. But one-sixth is the probability of throwing the ace.
_Principle_—Multiply the sum to be gained by the fraction which expresses
the chance of gaining it, and the result is the greatest sum which
should be given for the chance.”[3] “A man should not hazard his all
on any terms.” Does a man who enters upon a career of speculation take
the trouble to consider at starting whether or not his first operation
places him in a position in which he hazards his all? There is not
probably one speculator in a hundred who ever thinks of it at all. We
will suppose a man to be worth £200 in cash as his all, applicable to the
payment; of losses. It may safely be stated that numbers of speculators
open accounts with a less sum, in fact a considerable proportion of
speculative operations are entered upon in reality without any funds
at all; misfortunes in other vocations being frequently followed by
gambling in the Stock markets. A speculator with £200 to pay losses with
is in this position if he buys, for instance, for the rise £5,000 of any
English railway stock; a fall of 5 per cent., which even in two or three
days is nothing very extraordinary, carries him £50 “under water.” What
can he reckon upon on the other side, by keeping the account open, that
is a mathematical certainty like the occurrence of an ace one time out
of six in the long run in throwing the die? If he be exposed to such a
loss at any moment as that mentioned, the risk is an absurd one to run
if there is not at least an equal chance of a similar rise, and several
times £250 in reserve. But all experienced in Stock Exchange fluctuations
know that upward movements are, as a rule, gradual, a rise of 1 per
cent. being considered as a profit which a speculator should without
hesitation take, while a fall all round in a market of two or three per
cent. in a day is of more common occurrence.[4] It may here, perhaps,
be retorted that if a fall of 5 per cent. is nothing very extraordinary
to happen in a few days, while a rise is, as a rule, gradual, why not
speculate for the fall? The answer is, that the public are very seldom
indeed bears. It goes against the grain. Speculation with the public,
as a body, is a fair weather game. When the most potent influences are
affecting the Stock markets downwards, ordinary people hold aloof. We
shall go more into detail with reference to this peculiarity farther
on. That it is so is a fact, and it is easily accounted for. When you
are dealing with a die, a hexagonal body, you know that it must fall
on one of its six sides, and that each side to a certainty will have
its turn, and therefore a mathematician is able, from there being a
limitation set to the risk incurred, to estimate to a fraction what
amount a thrower of the die can afford to venture, five times out of
six, on the chances of the ace turning up, so that in the long run he
will not lose. A game of die-throwing for money, conducted by one of two
players upon principles based upon the doctrine of probabilities, and
upon conditions to give him a certain profit, can only be continued for
a short time, as the absurdity of it becomes speedily evident to the
other player, and play ends. Those with whom outside speculators deal in
the Stock markets get all the profit also in the long run, much upon the
same system that professional bettors on horse-racing always win in the
long run by backing the field. In the die-throwing gambling there is no
mystery, at least very little for the ordinary understanding. A person
of average intelligence who is quite unable to comprehend that it is a
mathematical certainty that a die will show the ace upwards, in the long
run, one time in six, can be got by simple observations to see that in
a great number of throws the ace will have appeared about as often as
once in six throws. The fact of his losing his money through betting that
it would not be so would, in any case, bring the truth home to him. The
case, however, of speculation in the Stock markets is very different.
Although so large a proportion of speculators speedily lose their money,
a large proportion of them also, when quitting the arena through want of
capital to go on with, seem to entertain a strong conviction that money
is to be made at it. There is very frequently an impression left that if
this and that, and the other, had been done instead of what was done,
the result would have been otherwise. They regret that their purse was
not longer that they might try again, feeling sure that with such a rich
experience they would avoid the mistakes that had landed them losers. The
Stock Exchange speculator has an innumerable number of influences arrayed
against him, at least one-half of which he never sees at all until, like
the sunken snag, which sinks the steamer without any warning, one or
other of them wrecks his fortunes before he is aware of his danger.
A speculative operator has a very dangerous basis upon which to lay the
foundations of the argument by which he endeavours to justify himself,
and it is this. He says to himself: “there are only two ways for a price
to move—up and down.” At first sight the chances seem to be as much in
his favour as against, and he thinks the failure of others to make a
profit must have been the result of mistakes made by them, which he will
avoid. But does it occur to such an one that if there were any easy and
certain method of making money by speculating in stocks everybody who had
a little capital would at once commence to speculate? Speculation in the
Stock markets has almost irresistible attractions as a mere amusement,
quite apart from its being a kind of occupation which is the most
luxurious and exciting mode of making money. It must be evident therefore
from the comparatively few persons who habitually speculate, that large
numbers are simply driven away from the markets through a conviction
that such a vocation must end in disaster. The dangers of Stock Exchange
speculation are made apparent when, as a species of gambling, it is
compared with the games of chance, whose evil effects upon the community
have been at last recognised by the abolition of the tables at Hombourg,
Ems, Baden Baden, &c. The conductors of the Bank at the Palais Royal were
fully alive to the necessity of limiting the stakes, and also as regards
the number of persons with whom they would play at once. Governments
are stepping in by degrees to suppress gaming houses, and it would have
been more to the credit of Germany if the tables at the above-mentioned
places had been done away with while the effects of the golden stream
from beyond the Rhine were as yet unfelt by the comparatively poor
exchequer at Berlin. The interference of a government is shown again by
our own legislature having declared that A should not insure the life
of B, unless it can be shown that A has some pecuniary interest in B’s
continuing to live. The law, however, is for the most part evaded. Such
systems are therefore looked upon as bad; but because it is difficult
for governments to define in Stock Exchange gambling where _bona fide_
business ends and the gambling begins, the most injurious of all games of
chance is played year after year upon an increasing scale. At the first
beginning of prosperity with a comparatively poor community, gambling
springs up in these times in stocks and shares. As a result of such
operations Vienna went half mad in the first half of 1873, which was
followed shortly after by a financial crash and the suicides of certain
bankers at Posen. Older communities, which have passed through the only
crucible which in this life teaches people that if money is to be
made rapidly the process must be attended with a proportionately large
risk, are observed, as time goes on, to be less exposed to the headlong
financial panics such as that in which the speculation at Vienna lately
culminated. Commercial revulsions of one sort or another, and of greater
or less violence, will probably occur during all time at intervals,
wherever commerce is carried on, but the gradual fashioning of laws
with the view to confine the injurious effects of over-speculation and
over-trading within limited areas, as for instance the limited liability
acts, will more and more render it possible to stand between the dupe and
the financial sharper, and also to observe the gathering together for
harm of the dangerous influences, so that they may be provided against in
time, or checked at an early stage of the disease. Among the operators at
younger commercial centres there is a more feverish desire to gain, but
the efforts to satisfy it are not kept in check in the same degree as in
places where memories of disaster cluster in traditions among the people,
and inspire the growth of prudence, almost as if it were an instinct.
Farther on we shall call attention to the way in which an outside
speculator on the Stock markets is handicapped with turns, commissions,
and contangoes.[5]
Very few persons, if any, will be found to dispute the statement that
speculation on the Stock Exchange is gambling. The highest mathematical
authorities maintain that there are but two conditions under which
gambling can be prudently followed as an amusement, viz.: small stakes,
and equal play.
The ordinary gambler in the Stock market is no better off, as regards
his chance of winning, than a player against a bank, which can only make
certain of winning against all comers in the long run by the protection
of a mathematical advantage. In the case of a bank established as a
gaming-house the initial condition of existence has always been in the
long run either bankruptcy to itself, or ruin to the individual players.
As the banks have always flourished, the players, in the long run, must
always have been losers.
A gaming-bank is an institution with limited means offering to play all
who enter; or, in other words, it is limited means against unlimited
means.
The Stock Exchange occupies a parallel position to that of the bank, and
the operators[6] in the markets are protected in such a way that the
outside player at speculation must in the long run lose, or no one would
be found to take up his challenge. It must be obvious that supposing
an outside speculator had any advantage when speculation in stocks and
shares were first practised, and through such an inequality of terms he
was on the average the gainer, experience would soon show the necessity
of rectifying such a state of things, and what would be tantamount to
the mathematical advantage secured to the gaming-bank would be speedily
arrayed against him.
The number of people who play publicly at games of chance is very small
compared with the number of people who gamble in mercantile transactions.
And whereas the former are diminishing, partly from compulsion, as in
the case of Germany of late, and partly through the more enlightened
state of the human understanding as regards the immorality of this kind
of amusement, the latter appear to multiply in proportion to the general
increase of wealth, the ever enlarging fields in which public securities
are dealt in and commercial transactions are negotiated, and also in
proportion to the facilities afforded for speculation generally. The
latter part of this sentence should, however, be qualified by the remark
that the spread of wealth enables younger and less experienced persons to
engage in speculation in a larger proportion as compared with the whole
community than formerly. The difficulty of living and the ambition not
to fall below the standard maintained by the well-to-do, tempt numbers
of young men to endeavour to increase their income by speculation. And
moreover as regards Stock Exchange speculation it is unfortunately much
against the interest of the stock broker to make public the failure of
his clients, hence it is seldom that the wholesome warning of publicity
deters others from entering the arena.
Outsiders entering upon speculation with professional dealers in the
Stock markets make two mistakes on the threshold. Firstly, they commence
upon unequal terms, the effects of which adventitious favourable
influences have never more than compensated for, in the long run.
Secondly, supposing the terms were permitted to be equal, the outsiders’
stakes would be too large a proportion of their means. The losses
incurred by speculators as a body have always been upon such a scale as
to dispose of the theory advocated by some persons that the mere charges
of commission, contangoes, and the “turn” are the only obstacles to
success.
Now, if the playing of public games of hazard are on the decline from
the interference of the State on moral grounds, the question arises: are
there any considerations applying to Stock Exchange gambling, which,
as a game, raises it above other games of chance, and entitles it to
special privileges? Does the outside haphazard speculator stand a better
chance as against the Stock Exchange, than a player at _Rouge et noir_
against the bank? The answer must be No. Exactly the same considerations
apply to commercial speculations as to other games of chance in which no
absolute certainty exists. Mathematicians lay it down as a law, that if
any possible event which cannot frequently occur in a game of chance,
but which is, nevertheless, a part of the nature of the game, if a bet
or stake be made upon the recurrence of that event in a proportion to
some large gain which it is agreed that event shall secure, then prudence
demands that the game shall be often played; and if this be impossible
it shall not be played at all. Here we come to the crux of the whole
question of Stock Exchange speculation. Unless a speculator, handicapped
as we shall show he is to start with, has enough means to enable him
to hold out for the arrival of the event, the occurrence of which is
absolutely necessary to his keeping above water, he should not speculate
at all.[7]
What is the one event constituting the benefit for which the speculator
operates? it will be asked. The answer is, the greatest fluctuation in
the direction favorable to him which may be caused by any one of the many
influences that may spring into action at any time. This is part of the
mystery which allures people on. If you tell persons who are throwing a
die that the six will turn up once in six times in the long run, they can
form some estimate of their chance of winning. But until a Stock Exchange
speculator has been roughly undeceived, his understanding gets entangled
so that what he sees clearly only at first, is what is in his favour,
because his first interest is to discover that. What is against him, he
disregards until he has discovered it has undermined him, and all goes
together.
In cases where the public play against a bank, it is so managed that
the bank has a better chance than the players. It is so managed that a
considerable succession of losses can be sustained against the good luck
of any comer. One side always secures to itself the benefits of _the long
run_. The haphazard speculator stands at the same disadvantage as the
player against the bank. His position is always relatively inferior. When
the balance is nothing, as worked out by the following rule as stated by
De Morgan, then the play is equal:—“_Multiply each gain or loss by the
probability of the event on which it depends; compare the total result of
the gains with that of the losses: the balance is the average required,
and is known by the name of the mathematical expectation._”
It must stand to reason that an outside speculator plays upon unequal
terms, otherwise it could not be worth the while of the other side to
engage him. As well might we expect a man to set up a shop and sell his
goods at a loss. Then we come a step farther, and ask if it be any use
for a Stock Exchange speculator to operate if the terms be equal? If
such numbers of persons find themselves induced, by the estimate they
are enabled to form of the chances in their favor, to play on terms more
favourable to their antagonists than to themselves, their prospects
would seem to be much improved if the terms were made equal. Although
the position of the speculator be improved to the extent of the terms
being equal, it is absolutely indispensable that the operations be kept
open for a considerable time[8] in order to secure the mathematical
expectation which can have no existence except through continuity. With
the play in favour of the gambler, he stands no chance even of holding
his own, unless he makes sure of being able to continue over such a
number of trials, or during such a period of time, as will give him the
benefit of an average of the ups as well as the downs of fortune.
As at cards so at Stock Exchange speculation, there must be two kinds
of luck, ill-luck and good-luck, as the changes of fortune which are
worth while taking account of. A man speculates, gets his turn of good
luck and pockets his gain, treating the money as if it were ore from a
mine, or something added to the realized wealth of the world, a pure
plus as compared with a plus leaving a minus. For every profit made by a
speculator, and for every realized profit made by a _bona fide_ investor,
there must be a corresponding loss. The man who in his turn is a winner,
must also in his turn be a loser, and what he was plus when he won, he
must be minus when he loses.
If the manager of gaming-tables secures to himself a mathematical
advantage only sufficient to cover the expenses, he will infallibly be
ruined at last. It may be in one year or in five, or ten, but ruined he
must be. But he provides adequately against this, and in the long run
those who play with him must be ruined. So it is with Stock Exchange
speculators.
It is the character of negative events to lay less firmly hold of the
mind than positive ones. The minds of Stock Exchange speculators are
like other people’s minds. A speculator will often attribute a certain
movement in prices to an influence which happened to be exercised at a
particular moment, and he contents himself with the apparent connection
of the two, and looks no farther. On another occasion, when operating in
the same way, immediately upon the recurrence of the same influence he is
bewildered to find prices move in an opposite direction. This comes from
being satisfied with any solution which lies on the surface, and chances
to catch the eye. It used to be supposed that comets were the cause of
hot weather, and the theory was considered to be well founded, because
more comets were seen during the summer months than at other seasons of
the year. Hot and cloudless weather is most favourable for seeing comets,
but they are no more productive of hot weather than is hot weather of
them. This circumstance being fixed upon by one class of theorisers,
shows how an event which is positive lays hold of the mind of any person
who may be interested in certain effects and is in search of the causes.
It is of great importance, in endeavouring to connect certain effects
with specific causes, to mark carefully two distinct things, first,
the occurrence of an event, and, secondly, our observation of it. Many
entirely wrong deductions as to the causes of fluctuations in the value
of money, and in the prices of Stock Exchange securities, are made from
negligence in this respect.
As every rule has its exception, so in speculation are there a few
professional experts who succeed at it as a business. What is contained
in these pages is not for the expert, who is well able to take care
of himself, but for the ordinary haphazard operator. The professional
speculator, who has the right sort of head, sufficient capital, patience,
perseverance, coolness, and a business-like aptitude for laying down
the elaborate machinery that is necessary for mercantile success, may
succeed. In the following chapters it is our intention always to make
this reservation, and in speaking of the speculator, who must always
lose in the long run, we refer to the ordinary run of men, whom we will
designate as haphazard speculators.
THE THEORY OF STOCK EXCHANGE SPECULATION.
CHAPTER I.
TECHNICAL TERMS EXPLAINED.
[Sidenote: JOBBERS AND BROKERS]
The members of the Stock Exchange are of two descriptions, jobbers and
brokers. The jobber[9] deals in stocks and shares, either as a buyer or
seller, at the market prices. The broker deals with the jobber, and is
paid a commission by his principal for transacting the business between
the two.
[Sidenote: THE BULL.]
A bull is a speculator who buys for the settlement[10] with a view
of selling at some future date at a higher price, and gaining by the
difference.
[Sidenote: THE BEAR.]
A bear is a speculator who hopes to gain by the reverse operation. He
sells for the settlement, hoping to buy back at a cheaper price, and gain
by the difference.
[Sidenote: CONTANGO.]
Contango[11] means continuation charge; for instance: if a bull operator
has £2,000 Brighton railway stock open for the account, of which there
are two in a month, one in the middle and one at the end, and the
settlement which is to take place, say in the middle of the month, is
approaching without the price having advanced as much as he supposed it
would at the time when he bought, he wishes to carry over or keep the
stock open for another fortnight. For this accommodation he must pay the
jobber in the House of whom the stock has been bought, a certain rate per
cent. to allow the speculator to continue a bull of the stock, instead
of paying the money and taking it off the market. The contango rates
depend upon different circumstances. Sometimes, instead of having to pay
any contango, a bull will get something paid to him. If the stock is
very scarce, and the jobber finds it difficult to deliver to purchasers,
he will be glad to carry over a bull account for nothing, and may be he
will pay a consideration to postpone delivery for a fortnight.[12] On
the other hand, if the stock is very plentiful when the settling day
arrives, if the sellers have been numerous, and the deliveries are large,
the jobber will prefer delivering the stock to the bull speculator to
continuing it to the next account, because he wants money to pay those
who have sent their stock to market. Under these circumstances the
contango rate may be ¼ per cent. on the money price of £20,000 nominal
stock for the fortnight, or it may reach a much higher figure, even
exceeding one per cent. for the fortnight, but such a rate is seldom
charged.
The contango rates depend very much upon the state of the money market,
and hence the fluctuation in the price of public securities in sympathy
with the rise and fall in the value of money.
It has become more of a custom with bankers to lend money to the Stock
Exchange than was the case formerly; one reason being that, through the
more enlightened management of the Bank of England of late years, the
changes in the rate of discount are made more in obedience to the varying
condition of the money market as a whole, as reflected in the Bank
return, than was the case in former years, when the directors would come
down to the City some Thursday afternoon to put up their terms when there
was very little available money left upon which to obtain the increased
charge. In other words, the value of money changes more frequently
than it used to, and bankers, desiring to act at all times in view of
contingencies, find it very convenient to lend their surplus balances
for a fortnight upon easily convertible securities with a good margin.
Moreover the risks attending bills of exchange are avoided. The contango
rates at the settlement may rise suddenly through unexpected demands
upon bankers arising out of a bullion drain, and a fall in the foreign
exchanges, which compels them to refuse to continue their loans upon
stock. Such stock must then be turned out upon the market, and, if there
happen simultaneously to be more deliveries than there is stock taken off
the market, the contango rates will rule high.
It may be here observed that the contango charge is an item in the cost
of speculation which the haphazard operator seldom takes into account
at all; yet, if speculation be engaged in upon a large scale, the item
of contango charges may become a formidable one, and, when added to the
commission charged by the broker, takes so much out of the possible
advance in price which may take place in the period of, say, two
accounts, or the space of one month, that it requires no great experience
to show that the game is not worth the candle, taking one operation with
another.
Take a case in point:—A speculator buys £5,000 Turkish 5% ’65 stock at
£50, for which he engages to pay £2,500 on the settling day, which is
the last of the three account days. He pays ⅛ commission to the broker,
or £6 5_s._ When the settlement arrives, we will suppose he has been
very lucky, and has got a rise of ½ per cent. in the price, which is
a good advance for a class of stock which investors do not like, but
nevertheless is speculated in a good deal. How does the account to be
rendered to him stand, with 6 per cent. contango for carrying over the
transaction?
DR.
£ _s._ _d._
5000 Turks. 5% at 50 2500 0 0
Commission ⅛% 6 5 0
Balance 18 15 0
-----------------
2,525 0 0
-----------------
CR.
£ _s._ _d._
5000 Turks. 5% at 50½ 2525 0 0
-----------------
2,525 0 0
-----------------
The operation so far is successful, and the speculator, taking courage
from his success, awaits a further advance. He is not disappointed, we
will suppose, and the stock continues to rise, to give him the favourable
start which is so frequently the cause of his future troubles and losses.
During the next account the stock gains a further ¼ per cent., and he
credits himself mentally with an additional £12 10_s._ Here is a gain
of £37 10_s._ minus the selling commission, which is generally charged
when the stock is not bought and sold in the same account, and also minus
the contango. This second commission, which is usually charged when a
speculative account is kept open for a month, is frequently left out of
the calculation by novices. Supposing, then, towards the close of the
second account, there occurs a relapse of ⅝ per cent., making the price
really ⅜ lower, which is a very reasonable hypothesis, as stocks do not
always move in one direction,—how does the account to be rendered at the
next settlement stand? We have—
DR.
£ _s._ _d._
5000 Turks. 5% at 50½ 2525 0 0
Int. 6% 15 days 6 4 6
Commission 6 5 0
-----------------
2,537 9 6
-----------------
To Balance £12 9 6
CR.
£ _s._ _d._
By Balance 18 15 0
5000 Turks. 5% at 50⅛ 2506 5 0
Balance 12 9 6
-----------------
2,537 9 6
-----------------
It becomes apparent, in examining this account, the extreme danger the
speculator was in just at the period immediately preceding the relapse,
and forcibly demonstrates the importance of acting upon the soundest
of maxims in “time bargain” operations, which is, _never to refuse a
profit_. We have been supposing the speculator to have been “running
the stock,” as the saying is, for nearly a month, during which period
it had been advancing in price. At the same time he had been incurring
expense to have the chance of making a profit by such advance. After
carrying over the transaction, he had incurred the certain loss in any
case of the two commissions and the contango charge, which make together
the sum of £18 14_s._ 6_d._ It seems almost incredible that, under such
circumstances, he should still hold on when he could close with a profit
of £18 15_s._; instead of which he closes with a loss of £12 9_s._ 6_d._,
after having commenced to operate with just as reasonable a prospect of
a fall of ½ per cent., and another on the top of it of ¼. On the other
hand, everything went as well as can ever be expected on a series of
operations, and yet he finishes with a loss. The charges, to begin with,
kill the profit, to say nothing of the “turns” of the dealers, and the
risks of the fluctuations in price.
[Sidenote: BACKWARDATION.]
Backwardation[13] is the term for the charge paid by the speculator
for the fall. The word itself implies that the charge is for holding
back a transaction, as directly opposed to that for which a contango is
paid. The one is to carry forward, and the other to carry backward. A
speculator who sells for the fall, and thereby makes himself a bear, must
pay something if he wishes to keep the transaction open; just as the bull
must, unless exceptional circumstances are influencing the market. When
the settlement arrives, a bear must either deliver what he has sold, or
pay the backwardation demanded for postponing delivery; which, in other
words, is the price paid for obtaining the stock elsewhere. If the supply
of stock should chance to be large, he will find it very easy to continue
his bear account, because the stock he has sold is not wanted. Under such
circumstances, the position of the bear speculator comes to be the exact
antithesis of that in which the bull finds himself at the settlement when
the stock he has bought is scarce. In both cases the charges recede until
either the transactions are carried over “even,”[14] that is to say, for
nothing, or it may be the speculator receives a consideration. As in all
other markets, it is a question of paying or receiving, and the one or
the other depends upon the relation which the demand bears to the supply.
As we shall have occasion farther on to speak more minutely upon bear
speculations, we shall not pursue the subject at any length here; suffice
it to say that the public, as speculators, do not understand selling for
the fall. It goes against the grain. Speculating at all is associated,
in the minds of nearly all people, with fine sunshiny weather, and a
settled state of the political atmospheres of one’s own and neighbouring
states. The time to speculate for the fall is when growling despatches
are being exchanged between nations whose prosperity has reached a zenith
where nothing more is to be had, except by quarreling; when the exchanges
are adversing, and there is a drain of gold setting in and the biting
winds and sleet of chill October fill everybody with pessimist views;
when the reports of shipwrecks and hurricanes at sea fill the minds of
Oriental merchants with alarm for the safety of their galleons, and there
is an uneasy general impression creeping over the public mind that it is
perhaps prudent, under the circumstances, to hold less in securities, and
to have a larger balance at the bank. Yet, when the very air seems to
whisper coming difficulties and disturbances, and the time is ripe for
speculating for the fall, such is the weakness of the human character
that the opportunity presented is seldom discerned until the return of
sunshine, and the blowing over of the storm has shown the inutility of
being wise after the event.
[Sidenote: OPTIONS.]
[Sidenote: THE “PUT AND CALL” OPTION.]
Speculation by “options” is of all methods of speculating the most
prudent, as it is the most sensible, for all parties concerned. It
resembles in some degree the lottery-ticket mode of gambling. The
indefinite mischief that is caused by speculation which allows the
operator to incur unlimited risk on credit is prevented by the system of
options, inasmuch as a fixed payment must be made by the speculator at
the time the option account is opened. There are three kinds of options.
First, is the “put and call,”[15] which means to take or to deliver stock
at a fixed price at a future date, for which a certain sum is paid on the
day the bargain is entered into.
[Sidenote: THE “PUT” OPTION.]
The second is the “put,” which means the option of delivering a specified
amount of stock at a fixed date, the price and the day of delivery being
agreed upon at the time the money is paid.
[Sidenote: THE “CALL” OPTION.]
The third description of option is the “call,” which means an operation
exactly the opposite of the “put.” It is the option of claiming a
specified amount of stock at a future fixed date, such date, together
with the price, to be agreed upon at the time the option money is paid.
The sum of money that is paid for options fluctuates in sympathy with
the changes in the value of public securities, and also depends upon the
amount of business doing. An option may be done from day to day, or from
account to account. The option money is paid by the principal to the
broker at the time the transaction is effected. When the option expires,
the person who has paid the money declares whether he buys, sells, or
does nothing.[16]
Years of experience of this mode of speculating have only shown, as with
other kinds of speculation, that the option money once paid is hardly
ever recovered. We have taken the trouble to inquire of those who have
been for as many as thirty years in the markets, and such is their
experience.[17]
[Sidenote: THE FORTNIGHTLY SETTLEMENT.]
The Stock Exchange settling days are in the middle and at the end of each
month. Each fortnightly settlement occupies three days; the first is the
carrying over or contango day, the second is the name or ticket-day,
and the third is the day for paying the differences, or the amount of
money for stock or shares to be taken off the market. The settlement in
Consols is monthly, and near the commencement. The extent of the business
transacted in the Stock markets has been very accurately measured since
the establishment of the Clearing House. All transactions being settled
by cheques, the increase in the Clearing House totals on a Stock Exchange
settling day correctly indicates the amount of money which has passed
between buyers and sellers.[18]
[Sidenote: SPECULATION BY MEMBERS OF THE HOUSE.]
Speculation inside the Stock Exchange by members of the House does
not present many features which entitle it to comment apart from the
speculation as it is practised by the public outside. It is natural to
suppose that members of the Stock Exchange are better able to operate
in stocks and shares, with a view to profit by speculation than the
public who, as a rule, are ignorant of the art they endeavour to practise
until all they have left is some bitter experience. Those whose daily
business it is to be in the Stock markets must of course know that the
outside public are always dropping their money, and in this respect the
conviction comes nearer home to them that the play is not worth the
candle. There are speculators who are members of the Stock Exchange, but
we believe it is but a very small minority that troubles itself with
speculation as the principal means by which the profits are made. As a
rule, it may be laid down that a dealer who goes out of his market to
speculate is just as likely to lose his money as an outside haphazard
speculator. Each stock, and each description of shares, has its history,
and is influenced more or less by special causes, as well as by general
causes. Each stock, therefore, requires to be constantly watched, after
it has been studied, and its peculiar characteristics well ascertained.
When it is said that these stocks and shares are numbered not by tens,
or by hundreds, but by thousands, it is easy to understand that no one
man can master the special knowledge concerning each, which however every
jobber who understands his business should do, within the limit of those
in which he usually deals. Consequently, a jobber devotes himself to a
few descriptions which circumstances or inclination may cause him to
select. He confines himself to a particular market, where he is to be
found; and if he speculates now and then, apart from the necessities of
his business, and to satisfy a desire for a little excitement, or because
some special view of the course of events encourages him to try his luck,
it is, as a rule, in the stocks in which he is accustomed to deal.
* * * * *
It may be of interest to some persons to contrast the terms used in
England with those employed by stock-brokers and jobbers across the
Atlantic, and we append those in use on the New York Stock Exchange, with
explanations. The inventive resource which is so characteristic of the
American, crops up in the terms used in their Stock markets, as in the
case of the “put and call” option with us, which the Yankee cannot be
satisfied with, but must invent the vulgar synonym of “straddles,” which
is certainly expressive of the pair of operations in one. The mania for
getting rich by making short cuts and royal roads engenders apparently
an impatience of terms which contain a single syllable or letter that
is unnecessary, however hallowed by time, and hence, “put and call” is
superseded by “straddles.” [19] The “put” is a contract by which, during
a fixed time, usually thirty days, a seller for a consideration agrees to
take from a buyer of a “put” a stock at a given price, generally several
per cent below the market value.
The “call” is an operation of a directly opposite nature, being a
contract by which for a consideration a seller of a “call” undertakes to
deliver to a buyer a certain stock at a given price, generally several
per cent. above the market value.
To “put up a margin” signifies to deposit with your brokers a sum of
money, as a rule 10 per cent. of the par value of a stock, as security
against failure to meet losses.
To buy “long” is the equivalent of our term “bull.”
To sell “short” is the equivalent of our term “bear.”
To “corner” a stock is to purchase all that can be obtained and make
it very scarce, and also more than can be obtained, in order to run
the price up, and “roast,” as the saying is in the London market, the
speculative sellers; but the “cornering,” as we understand the meaning
of the word, would seem to apply more to the speculative sellers who are
“roasted” than to the stock which may be selected for the operation.
“Clique,” “pool,” or “ring” are less expressive, and in consequence of
other associations, are less happy terms than our equivalent syndicate,
which in English financial circles can be mistaken for nothing else
than a combination of speculative capitalists which is formed either to
divide a loan amongst them and unload their portions upon the public as
opportunities may occur, or to “wash” a stock up and down, getting what
they can out of the unwary public during the operation. Gold “rings” on
the other side of the Atlantic, and foreign loan syndicates on this,
must by this time almost have had their day. Each new era of prosperity
requires and generally witnesses a new set of ingenious devices to throw
dust in the eyes of investors, while the new race of Autolycuses are
going through all the old tricks.
In London, settlements take place twice a month, but in Broad Street
sales are made for either cash or “regular.” In the first case purchases
have to be settled the same day before 2.15 P.M., and in the second on
the following day. Time contracts correspond to our time bargains, and
have about the same conditions attaching to them, with the exception that
the rate of interest charged, answering to our contango, is generally
6 per cent., unless otherwise stipulated, and is not influenced by a
varying standard such as our Bank rate.
The word “shrinkage” for depreciation is a neat term with which the small
catalogue may be euphoniously terminated.