The Facts about Speculation by Thomas Gibson

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Thomas Gibson warns of the repeated mistakes made when people speculate in the stock market. The classic, written in 1923, adds historical context to long-held investing advice.

The Notes

• “Speculation is truly an unbeatable game, but it is not an unbeatable business.”
• “A share of stock is an undivided interest in some line of enterprise — just that and nothing more.”
• “There is overwhelming evidence that speculative operations conducted in even the best securities on insufficient margins, on erroneous conceptions of values — particularly future values, or in opposition to economic conditions and prospects, will inevitably result in loss in the long run. And it is pertinent to note that a grocery store or a haberdasher’s shop conducted along the same lines would also fail.”
• Speculation, in and of itself, is not a bad thing. It is a driving force behind entrepreneurship. Few businesses would have been started without it.
• Gibson recalls a study he did on 4,000 brokerage accounts. About 500 of those accounts were in a single stock — US Steel — covering 12 months. The stock price was the same at the beginning and end of the period, with a difference between high and low price of 16 points. The following things stood out:
  • The average account lost money.
  • Most of the buying was done at a price above the average — the average price paid was within 4 points of the high.
  • Little buying was done at low prices.
  • Short sale losses were 20% greater than the losses on the long side.
  • About 10% of accounts used a rules-based process — scaling down — that was abandoned. “In every instance, all transactions based on the scale order would have shown a good profit if the plan had been rigorously adhered to.”
  • In accounts that used charts or other systems, 90% showed a loss.
  • Losses far exceeded brokerage commissions.
  • “The most glaringly apparent cause of loss revealed by the investigation of these accounts was the almost universal habit of making purchases at high prices after a material rise had already occurred. This error is of a wholly psychological character.”
• “Any man of average intelligence will realize and admit that the time to purchase securities is when prices are depressed, not when they are inflated. He will also realize and admit that there is a top to the market and that each point that prices advance brings them that much nearer to the top and consequently curtails the extent of possible profits. Finally, he will realize and admit that the extent to which prices may fall increases with each point of advance. The entire proposition as outlined above is as simple as a law in physics.”
• “…the great bulk of public buying of securities is done at the approximate top of a major cycle of prices, while most of the selling is done when prices are very low.”
• “The ceiling, as well as the floor of the security markets is invisible to the rank and file, and this is the principal cause of their undoing. The reason for this blindness is easily traced. It is due to the fact that nine speculators out of ten are influenced by surface appearances instead of by knowledge of values and a clear understanding of economic phenomena. It is certain that surface appearances will always be inspiring when prices are high, and it is equally certain that they will be depressing when prices are low.”
• “At the outset it is necessary to realize fully and definitely that large fortunes quickly acquired with a small capital are as rare in the field of security speculation as in the dry goods business, and that the element of time can no more be eliminated from market operations than from any other line of enterprise.”
• “When the mind has been cleared of the delusions of hope and the visions of sudden wealth, one will be in a position to approach the more constructive phases of the study and to learn what steps should be taken to equip himself for intelligent operations in the security markets. For some people the task will be found difficult.”
• “The action of the market represents the composite opinions of the brightest minds in the world registered upon the most delicate instrument in existence as to probable future developments. Intermediate security price movements or movements in individual stocks of time will show that the two have invariably moved in close relation to each other, except that the market precedes the actual business developments.”
• Causes of speculative losses:
  • Buying at high prices after a major advance.
  • Operating on insufficient margins or overspeculating.
  • Relying on tips and “market appearances.”
  • Relying on charts or similar systems.
  • Using stop-loss orders.
  • “Impatience and inability to await results.”
  • “To these may be added the psychological effects of greed and fear. In fact, greed and fear enter in some degree into all the errors summarized. Greed is responsible for over-speculation, for lack of discrimination in the selection of securities, and is a synonym for impatience. Fear causes people to sell when prices are low and, what is almost as bad, it causes people to refrain from buying when securities are intrinsically cheap.”
• “…the psychologists tell us that one of the most common of human errors is the propensity to assume that present conditions will be indefinitely projected into the future. This is, of course, a mischievous error when applied to the security market. It is simply another way of arguing that the higher prices go the farther they are from the top. But so long as human nature endures this error will persist, and until it is overcome there is little hope of making a success of speculative ventures.”
• “Over-speculation will eventually ruin any man who indulges in it. He may escape for a time and he will usually resolve that after the present deal is carried through he will be more conservative. But it works the other way, for each success makes the operator bolder and the first reversal will wipe out previously acquired profits.”
• “Unexpected reversals are certain to appear at times and no amount of vigilance or study can provide against this contingency. The only thing which can insure a reasonable degree of safety is a sufficient margin or sufficient reserves at all times.”
• “Declines in quoted prices do not necessarily imply any change in the value or future prospects of a corporation or its securities.”
• “The man who enters the stock market with tips as his basis of operations will never succeed.”
• “I have never known of a case where a man who depended on reading the tape was able to show a substantial and sustained gain. Some of these people gain a reputation for reading the tape because of a series of lucky guesses, which are certain to appear in flipping a coin or in any other guessing contest.”
• “There can be only one sound reason for purchasing or holding securities, and that is because they are cheap. If the buyer knew they were cheap he would surely not order them sold if they became cheaper.“
• “It is a fact that in no line of business or speculative ventures…are people so impatient of results and so dissatisfied with reasonable profits when they are secured. This is no doubt largely due to the fact that the annals of speculation are replete with tales of quickly acquired riches, and I regret to say that many people who act in an advisory capacity encourage these illusions in order to further their own ends.”
• “The errors springing from greed and fear are responsible for much loss in speculative ventures… When to these is added ignorance, the evil trinity is complete.”
• “One of the peculiarities in connection with greed is that a speculator will frequently over-extend himself and endanger his entire capital in order to hasten the process of accumulating profits when there is no reason for haste.”
• Mistakes are made when opportunities in the market are treated as rare rather than common irregular occurrences.
• “There is more chance of a wide price movement in a “mystery” stock than in a stock which can be competently analyzed. Therefore, we find the highly speculative public favoring blind issues which have a wide price range, neglecting to observe that the range may be as wide in one direction as in the other.”
• “Stocks of low par value, selling at low prices, are particularly favored by many speculators who confuse low prices with cheapness… A stock selling at $2 a share may be very dear, while a stock selling at $200 a share may be very cheap.”
• “A glance at the dictionary will quickly reveal the absurdity of attempting to speculate on what is known, yet that is precisely what most public speculators do. Experienced and far-sighted men buy securities because they have reason to believe that profits in a certain line or in all lines will soon increase. The inexperienced public speculator sees no reason for buying at such times, as surface appearances are blue and discouraging. But when the expectations of increased profits have crystallized into facts, surface appearances arc excellent. Then the psychological error heretofore referred to, i.e., the assumption that present conditions will be projected into the future, begins to get in its work. The fact that security prices have risen to a level which discounts or largely discounts the improvement which has occurred is lost sight of, as is also the fact that both business conditions and the security markets move in cycles; a major recovery being followed by a major recession.”
• “It is possible to determine on sound and reasonable grounds when securities are cheap in the light of future probabilities. It is also possible to determine when they are dear, but it is not possible to determine what the minor interruptions and reactions will be. These reverses are due to the necessities or whims of thousands of widely scattered speculators, or to accidents, or to some development affecting sentiment, or to technical conditions, or perhaps to manipulation.”
• “Those who have no clear ideas as to values and economic prospects are thrown into a cold sweat by every reaction and by the most absurd rumors or inventions. They rush to sell out their holdings and an hour or a day later rush to buy them back, usually at a loss of money and always at loss of peace of mind.”
• “A combination of cupidity, timidity, and ignorance is about the most hopeless combination imaginable. But we should not confuse timidity with caution. A well-developed bump of caution will sometimes result in the loss of an opportunity, because all the factors are not clearly defined. But it pays in the long run. Timidity never pays. It is as bad as rashness. We may be both cautious and bold, without being either timid or rash.”
• “Inability to accept a loss is one of the most common and most mischievous of the numerous errors found in connection with operations in the security markets. The investor suffers from it as frequently as does the speculator.”
• “Every man, whether he be an investor or a speculator should school himself against this habit of sticking to a bad bargain in the mere hope that something will happen to bring him out whole. The habit is illogical and expensive, and I regret to say that it is quite prevalent.”
• “The course of security values is determined by many developments, some of which cannot be even imagined, and the actual price movement is determined by the actions of thousands of widely scattered individuals who do not know today what they may do next week.”
• “Any device or formula which promises a reward without an equivalent in labor makes an irresistible appeal to the masses. And there is no more exacting and trying form of labor than research and concentrated thinking.”
• “It may be said that common sense is the most uncommon of all human attributes. Its possession and exercise calls for labor, reflection, self-denial and courage.”
• “It is an axiom in higher accountancy that “if we have nothing to compare, we have nothing to criticize.” The results secured by a corporation for a single year do not form a safe basis for estimating values.”
• “Failure to make allowance for the natural growth of population, production, and the rapid increase in the number of things used by trie- individual is responsible for many errors in interpreting progress of general business. What is technically called the “secular trend” must at all times be given close attention.”
• “The fact that security prices almost invariably discount what is generally known is quite well understood, but the application of this knowledge is more frequently neglected than any other simple principle connected with speculation.”
• “The speculative public sees only what is openly apparent. Those who examine more closely into conditions and particularly into probable future conditions will usually have an entirely different and much more dependable perspective than those who operate on superficial knowledge. Far-sighted operators will frequently be found on the selling side when the speculative public is buying, or on the buying side when the public is selling. As a matter of fact, that is invariably the case at or near the two extremes of a major movement.”
• “At certain times we are warranted in making purchases of all classes of industrial securities on broad general principles. After a period of severe depression and when security prices are at a low level we may count with a confidence that amounts almost to certainty on a recovery in both profits and security prices. But, sad to relate, the public never buys freely at such times. They are too much impressed by the gloom and pessimism which is bound to assume its most acute form prior to a recovery.”
• “The economic law that whenever profits become large in a certain line of business capital will flow to that line until the margin is adjusted to the general level is inexorable.”
• “The progress of earnings should first be examined over a period of years, care being taken to iron out and disregard abnormalities except in so far as they may favorably or unfavorably affect the cash or asset position of the corporation under review.”
• “The inexperienced speculator is likely to magnify the probability of profit and minimize the probability of risk and to allow hope to outweigh judgment.”
• “Under ordinary circumstances and in times when no acutely abnormal conditions prevail the middle ground between extreme speculative risks and stupid ultra-conservatism is the field of greatest profit with the minimum hazard. There is an ancient adage which reads “In the middle of the road one walks safely” and this applies very well to the speculative ventures of the reasonable man.”
• “At particular times great profits are rolled up rapidly because of abnormal conditions, coupled with mere luck. The few who have had fortunes thrust upon them in this way never keep them.”
• “The ego is strong in all of us, and each individual flatters himself that if he should make a great profit in a short period he would be wise enough to keep it. But the records do not show that this has ever happened. It is not in human nature that it should happen. A man who is bold enough to plunge in such a way as to turn a small amount into a large amount in a short time does not suddenly become conservative. We cannot endow the individual with two antithetical natures.”
• “I believe the average man would be better off if he never saw a quotation board or a ticker… Successful speculation is based upon a correct concept of the difference between present prices and probable future values, and speculation based upon any other foundation will fail.”

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