The first step in the education of the speculator should be to clear
away the illusions which have grown rank through ignorance, and
flourished through prejudice. We have heard, and continue to hear, a
great deal of ethical talk on this subject, most of which emanates from
people who are not authorities, and who have little real conception
of the subject. It would be pretty safe to assume that a majority of
these same instructors speculate themselves. They place an arbitrary
construction on the word however, and draw a dividing line between
stock or cereal operations, and other forms of speculation, although
the basic principle is the same in all cases, i.e.: to buy what is
cheap and re-sell at a profit. One of the most ridiculous forms which
this pedantry assumes is the warning and preaching against speculation
by very rich men who made their own money speculating and could not
possibly have acquired it in any other way. Such expressions of opinion
are born largely of an exaggerated ego.
The trouble with these critics and advisers is that they seldom
approach the subject in the right way. With a full knowledge of
the fact that speculation is an inherent part of human nature, and
that a majority of human beings are bound to indulge in it in spite
of everything, these sophists simply rail against the practice
indiscriminately instead of attempting to point out what is foolish
and fallacious. If we attack the practice in a general way little
will be accomplished. If we say, “do not speculate,” our audience
will perchance give us a respectful hearing,--and go on speculating.
If, however, we point out what is dangerous and unreasonable, confine
ourselves to attacking the evils and explaining the delusions,
some good may be done in an educational way. We may, if we show by
simple logic that the education and qualifications necessary to
success are too difficult to acquire, actually deter many people
from speculating in certain lines at all, a thing which could not
possibly be accomplished by mere blanket warnings against the practice.
One of the most serious blunders in the world is the common one of
under-estimating other people’s intelligence. People are ready and
willing to learn, and that they do learn is shown by the decreasing
crop of lambs. It is not nearly so easy for the dishonest promoters and
manipulators to market poor securities at high prices today as it was a
few years ago. And in this regard it may be pointed out that the press
has actually, although in many instances unconsciously, accomplished
a great deal on exactly the lines suggested above. Magazines and
newspapers have, in recent years, taken on an educational character.
Periodicals once devoted to fiction or history now deal largely with
business and social economics, and with the exposure of bad methods in
high places, the ruthless uncovering of false or misleading statistics,
and the simplification of questions hitherto involved; the public has
been gaining rapidly in education and understanding. The fact that much
space in leading periodicals is devoted to these subjects, is in itself
_prima facie_ evidence that the people can and will learn, for with
all due credit to the editors and publishers, it is certain that the
contents of magazines and newspapers are selected in accordance with
what the public demands and likes.
No one will attempt to deny that a majority of public speculators
lose. In a former volume, the present writer undertook to establish
by analysis of a large number of public accounts, the fact that 80%
of the participators lost money. A number of critics commented on this
statement as a body blow to speculation, asserting that the writer
had shown that there was “80% against the player.” These writers
proceeded to compare this percentage with that existing in games of
pure chance, such as roulette, faro, etc., and wound up by pointing out
the tremendous drawback to the speculator through percentage against
the player. It seems incredible that any sane man should fall into such
laughable confusion of ideas. The percentage of players who lose in any
game has nothing to do with the percentage against the player. If these
critics established anything at all, it was that speculation was not
gambling; for it requires only a moment’s reflection to see that in any
mechanical gambling game where there is _any_ percentage, no matter how
small, in favor of the game, the percentage of players who eventually
lose must be 100. This being the case, the gentlemen mentioned were at
considerable pains to prove that, as 100 per cent. of the players did
not lose, speculation was not a gambling game in the strict sense of
the word. That is to say, it could not be correctly compared with any
mechanical device where the element of skill was absent.
If we consider the matter in a gambling light, the percentage against
the speculator can be determined by the proportions of commissions,
interest, taxes, etc., to capital invested. Taking commission alone as
our basis, we will find that he who purchases a stock at $100 a share
and pays one-quarter of one per cent. commission, has a percentage
against him of one-quarter of one per cent. If the speculator trades
on limited margins the drawback increases accordingly. If we assume
that 100 shares of stock are purchased in a bucket-shop on a one point
margin, without intention or ability to “re-margin” the transaction,
the mechanical percentage is large (25%); if 10 points margin is
deposited, the mechanical percentage is reduced to 2½%, etc. In the
first instance, $25 or 25% of the $100 involved was lost when the
transaction was recorded, without any change in market price. In the
second instance, $25 was again lost or 2½% of the $1,000 involved.
There is no doubt that fluctuations in prices of securities, cereals
and staples are frequently used as a basis for mere gambling
transactions. But the most remarkable feature of the whole problem is
the fact that the percentage of loss in transactions is _greater_ than
the mechanical percentage. In the work already mentioned, the writer
undertook to establish this. In 500 accounts examined, there was a loss
of $1,245,000, and profits of $288,000, leaving a deficit of $957,000.
The commission charges and interest amounted to only $275,000. There
thus appeared a loss of $682,000 which could not be attributed to a
gambling percentage. It may be added that the period considered in the
computations was from July, 1901, to March, 1903, and that the price of
the stock considered (U. S. Steel Common) was the same at the beginning
and the end of the period.
This tends to again refute the theory of mere gambling, with a ruinous
percentage against the player, for no mechanical device could by any
possibility operate against the player to a greater extent than the
fixed percentage in favor of the machine. A gambling machine will stick
to its knitting. If, for example, we take the simplest form of gambling
device--two dice thrown from a cup,--we know that certain numbers
formed by adding the total spots which appear uppermost will show more
frequently than others. Thus the number two can be effected in but one
way, the number three in two ways, the number four in three ways, and
so on up to the number seven, which can be formed by six different
combinations, thus:
4 and 3
5 and 2
6 and 1
3 and 4
2 and 5
1 and 6
from which point the chances decrease until the number 12 can be formed
in only one way--two sixes. This proposition applies to all forms of
mechanical gambling, and is so simple in principle, and so distinct in
operation that if we make a fair number of casts, say 1,000, and do not
make more sevens than any other one number, we may be positive that the
dice are defective, or loaded.
Therefore, if percentages hold true, we must attribute the surplus loss
in speculation to mental operations. In the total results mentioned,
these mental operations were so erroneous as to cause a loss greater
than the percentage itself; but, on the other hand, a certain number of
accounts showed profits; that is to say, the percentage was overcome,
which is again an obvious impossibility in true gambling.
The conclusion is offered, therefore, that not only can poor methods
and imperfect understanding result in losses far in excess of a
demonstrated drawback, but that this drawback may be overcome by
other and more correct methods. It is difficult to understand why
the opponents of speculation are continually harping on these points
of gambling and percentage as bearing particularly on operations in
stocks or commodities. If a man buys a certain security because it is
cheap, or because he considers it cheap, and pays a certain commission
to a broker for effecting the transaction, he is no more playing a
percentage game than if he purchases a piece of real estate because it
is cheap and pays the real estate broker a commission for his services.
Marginal trading is another abomination of the anti-speculative
element, but here again the critics do not discriminate between use and
abuse. Trading on insufficient margin is one of the greatest evils in
the speculative world and when, as is frequently the case, this evil
is combined with lack of knowledge as to values and conditions, the
result is certain loss. But what is objected to here is the hazy view
and comprehensive condemnation of _all_ marginal speculation. The line
of demarcation is usually carelessly drawn. If an individual buys 100
shares of stock for cash, has it registered in his own name and later
borrows funds from his banker with these shares as collateral, he
escapes impeachment as a marginal speculator; but if he buys on margin,
and borrows from his broker the unpaid balance, he is a gambler. And
yet it would be hard to point out the difference in the two methods.
If we wish to go a little further afield, we may reduce a very large
percentage of the commercial structure to marginal trading. We may, in
short, place in this category every merchant who buys goods on credit
and every man who buys real estate on payments, if their object when
buying is to sell at a profit.
It is highly probable that these contentions will be vigorously
attacked, on the theory that more evil than good results from
speculative ventures, and that therefore the whole structure should
be razed on a “greatest good to the greatest number” basis; but aside
from the intensely unphilosophical character of this view, it is not
at all probable that any such thing can be effected unless human
nature undergoes a radical change. Tear down every stock exchange in
the United States tomorrow, and people will be speculating, a majority
of them foolishly, in another week. The cure lies not in paternalism,
but in evolution and understanding. As has been said, more has been
accomplished in recent years by the educational crusade of the press
than by all the rantings and warnings of a century. We have our
periods of reckless over-indulgence, it is true, but the evil is
dwindling. The South Sea bubble would deceive a much smaller number of
people today than it did in the days of John Law.
It is the object of the present work to point out, so far as the
abilities of the writer will permit, what essentials are required in
any form of speculation, whether on margins, or masquerading in the
guise of investment. As to this last distinction, it may be stated that
the word “speculation” is herein taken to mean the purchase of any
security or commodity because it is considered cheap, with the ultimate
intention of disposing of the property so purchased at a profit. In the
writer’s opinion this definition is correct. Speculation contemplates
a rise in price, and an accretion in principal. Investment refers to
interest returns on money.
One of the most flagrant errors in speculation is an entirely mistaken
idea as to the _possibilities_ in this field. Nine men out of ten have
a deep-rooted conviction that if any individual could be right in his
main deductions for, say one or two years, he should make millions on
a small capital. This is a great mistake, and leads to numerous minor
errors which are productive of much loss in actual operations. The
business of speculation never did, and never will result in abnormal
profits. Large returns are sometimes made, it is true, but this fact
is also true of every other line of business. Certain individuals
grow very rich in Wall Street; this again is true of every commercial
branch. We hear now and then of a million dollar coup by a Morgan or a
Rockefeller, and do not stop to consider the great capital behind it.
If an individual makes five thousand dollars in a year’s speculative
ventures on a capital of twenty thousand, he is not considered a
Napoleon of finance, but he has accomplished much more, in proportion
to his capital, than Rockefeller would have accomplished if he had made
five millions on similar operations.
In a recent conversation with a number of gentlemen who clung
tenaciously to this idea of sudden riches, the writer undertook to
establish his contention. Tapes were secured recording the fluctuations
of sugar stock during a twenty point decline. The skeptics were given a
hypothetical capital of $10,000 each, subjected to the ordinary rules
of trading as to margins, etc., informed that sugar would decline
twenty points before it again touched the first quotation established,
and invited to “get rich quick.” The result was ridiculous in the
extreme. Two of the experimenters lost their imaginary capital trying
to double up and show large returns. The third took an unfair stand,
by selling the maximum amount at the inception of the experiment and
closing it after the 20 point decline had appeared. His operations,
therefore, proved nothing. Here was a case where two traders, possessed
of an absolute fore-knowledge of what was to occur, lost everything
through the fault of over-speculation and the belief that abnormal
returns could be made if the ultimate fate of a market could be
correctly forecasted. Even if we assume that _every_ intermediate
_movement_ were known in advance, that after a ten point decline there
would be a five point advance, and that transactions were conducted to
the full possibilities of both original margin and accrued profits, the
result would not be the millions which dazzle the eyes and imagination
of the unsophisticated. But to assume any such trading is foolish. The
factor of safety would be wholly absent. No wise man will ever attempt
pyramiding, and no foolish man who does, will succeed.
In order to clear the ground for discussion or study, the first thing
to eliminate is this wholly unsupported and mistaken idea of sudden
riches. No matter how correct the forecast of the future may be,
safety disappears in inverse ratio to the increased possibilities of
abnormal returns; and with the factor of safety continually ignored,
the final results are bound to be disastrous.
It will also be necessary to dispel another illusion. If the speculator
imagines that he can operate successfully without preliminary hard
work to fit him for the business in hand he is grossly mistaken. It is
necessary to qualify in this field as well as in any other. Knowledge
of monetary conditions, values, interest rates, and in fact, of all
influences bearing directly or indirectly on the future of prices must
be acquired and thoroughly understood. Ignorance on any one point may
mean defeat. On the other hand, a study of such conditions means a
liberal education, valuable in every line of business life. It may be
further stated that the man who attempts to evade necessary labor and
research by placing his dependence on tips or charts, or the opinions
of others, cannot hope to succeed. The gambling idea must be put out of
the question entirely, and means sought whereby intelligent opinions
may be formed by both inductive and deductive reasoning.
In preparing this work the temptation to enter more extensively into
fundamental principles has been great. It would be impossible to do
more than suggest a line of procedure in a single volume, and only
the most elemental requisites are set forth. And not only do the
prescribed limits of this volume forbid any exhaustive discussion, but
such discussion is unnecessary. On every subject of importance we have
books written by men of soberness and judgment, each a specialist in
his field. A bibliography has been appended to this volume suggesting
such works as are considered helpful. In this bibliography an attempt
has been made to choose such books as are clear and simple, rather than
those which are profound.
If the task as herein outlined, appears formidable, it may be said
that it is absolutely necessary, and not so difficult as may appear.
Before the student has entered far into the subject, he will find
the matter interesting and will very quickly realize that the well
grounded contentions and discussions of men who examine and diagnose
economical questions correctly, are of more value than the combined
tips, guesses and poorly based opinions of all the professional
speculators and gamblers from one end of Wall Street to the other. This
form of basic knowledge is just as important to the active trader as
it is to the investor. If he can correctly judge of the general trend
of future prices, he may operate safely _with_ that trend instead of
floundering around helplessly in a slough of indecision, or possibly
working directly against the current. If, for example, he has good
solid reasons for expecting ultimately higher prices, he will not be
disturbed by temporary reactions and, instead of being frightened out
of his position through ignorance, he will take advantage of such
reactions to make his purchases or cheapen his holdings. Knowledge, in
this particular line as in all others, is the foundation of successful
ventures.