Chapter I: Part 1

Transcriber’s Note
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PSYCHOLOGY
OF THE
STOCK MARKET

By G. C. Selden

Author of “Trade Cycles,” “What Makes the Market?”
Etc.

TICKER PUBLISHING COMPANY
2 RECTOR STREET
NEW YORK

PREFACE

This book is based upon the belief that the movements of prices on the exchanges are dependent to a very large degree on the mental attitude of the investing and trading public. It is the result of years of study and experience as fellow at Columbia University, news writer, statistician, on the editorial staff of THE MAGAZINE OF WALL STREET, etc.

The book is intended chiefly as a practical help to that considerable part of the community which is interested, directly or indirectly, in the markets; but it is hoped that it may also have some scientific value as a preliminary discussion in a new field, where opportunities for further research seem almost unlimited.

G. C. SELDEN.

New York, May 28, 1912.

Copyright, 1912
Ticker Publishing Company

CONTENTS.

I. The Speculative Cycle 9

II. Inverted Reasoning and Its Consequences 27

III. “They” 39

IV. Confusing the Present with the Future—Discounting 55

V. Confusing the Personal with the General 71

VI. The Panic and the Boom 87

VII. The Psychology of Scale Orders 101

VIII. The Mental Attitude of the Individual 109

I—The Speculative Cycle

Most experienced professional traders in the stock market will readily admit that the minor fluctuations, amounting to perhaps five or ten dollars a share in the active speculative issues, are chiefly psychological. They result from varying attitudes of the public mind, or, more strictly, from the mental attitudes of those persons who are interested in the market at the time.

Such fluctuations may be, and often are, based on “fundamental” conditions—that is, on real changes in the dividend prospects of the stocks affected or on variations in the earning power of the corporations represented—and again they may not. The broad movements of the market, covering periods of months or even years, are always the result of general financial conditions; but the smaller intermediate fluctuations represent changes in the state of the public mind, which may or may not coincide with alterations in basic factors.

To bring out clearly the degree to which psychology enters into the stock market problem from day to day, it is only necessary to reproduce a conversation between professional traders such as may be heard almost any day in New street or in the neighboring cafés.

“Well, what do you know?” says one trader to the other.

“Just covered my Steel,” is the reply. “Too much company. Everybody seems to be short.”

“Everybody I’ve seen thinks just as you do. Each one has covered because he thinks everybody else is short—still the market doesn’t rally much. I don’t believe there’s much short interest left, and if that’s the case we shall get another break.”

“Yes, that’s what they all say—and they’ve all sold short again because they think everybody else has covered. I believe there’s just as much short interest now as there was before.”

It is evident that this series of inversions might be continued indefinitely. These alert mental acrobats are doing a succession of flip-flops, each one of which leads up logically to the next, without ever arriving at a final stopping-place.

The main point of their argument is that the state of mind of a man short of the market is radically different from the state of mind of one who is long. Their whole study, in such a conversation, is the mental attitude of those interested in the market. If a majority of the volatile class of in-and-out traders are long, many of them will hasten to sell on any sign of weakness and a decline will result. If the majority are short, they will buy on any development of strength and an advance may be expected.

The psychological aspects of speculation may be considered from two points of view, equally important. One question is, What effect do varying mental attitudes of the public have upon the course of prices? How is the character of the market influenced by psychological conditions?

A second consideration is, How does the mental attitude of the individual trader affect his chances of success? To what extent, and how, can he overcome the obstacles placed in his pathway by his own hopes and fears, his timidities and his obstinacies?

These two points of view are so closely involved and intermingled that it is almost impossible to consider either one alone. It will be necessary to take up first the subject of speculative psychology as a whole, and later to attempt to draw conclusions both as to its effects upon the market and its influence upon the fortunes of the individual trader.

As a convenient starting point it may be well to trace briefly the history of the typical speculative cycle, which runs its course over and over, year after year, with infinite slight variations but with substantial similarity, on every stock exchange and in every speculative market of the world—and presumably will continue to do so as long as prices are fixed by the competition of buyers and sellers, and as long as human beings seek a profit and fear a loss.[1]

Beginning with a condition of dullness and inactivity, with small fluctuations and very slight public interest, prices begin to rise, at first almost imperceptibly. No special reason appears for the advance, and it is generally thought to be merely temporary, due to small professional operations. There is, of course, some short interest in the market, mostly, at this time, of the character sometimes called a “sleeping” short interest. An active speculative stock is never entirely free from shorts.

As there is so little public speculation at this period in the cycle, there are but few who are willing to sell out on so small an advance, hence prices are not met by any large volume of profit-taking. The smaller professionals take the short side for a turn, with the idea that trifling fluctuations are the best that can be hoped for at the moment and must be taken advantage of if any profits are to be secured. This class of selling brings prices back almost to their former dead level.

Soon another unostentatious upward movement begins, carrying prices a trifle higher than the first. A few shrewd traders take the long side, but the public is still unmoved and the sleeping short interest—most of it originally put out at much higher figures—still refuses to waken.

Gradually prices harden further and finally advance somewhat sharply. A few of the more timid shorts cover, perhaps to save a part of their profits or to prevent their trades from running into a loss. The fact that a bull turn is coming now penetrates through another layer of intellectual density and another wave of traders take the long side. The public notes the advance and begins to think some further upturn is possible, but that there will be plenty of opportunities to buy on substantial reactions.

Strangely enough, these reactions, except of the most trifling character, do not appear. Waiting buyers do not get a satisfactory chance to take hold. Prices begin to move up faster. There is a halt from time to time, but when a real reaction finally comes the market looks “too weak to buy,” and when it starts up again it often does so with a sudden leap that leaves would-be purchasers far in the rear.

At length the more stubborn bears become alarmed and begin to cover in large volume. The market “boils,” and to the short who is watching the tape, seems likely to shoot through the ceiling at almost any moment. However firm may be his bearish convictions, his nervous system eventually gives out under this continual pounding, and he covers everything “at the market” with a sigh of relief that his losses are no greater.

About this time the outside public begins to reach the conclusion that the market is “too strong to react much,” and that the only thing to do is to “buy ’em anywhere.” From this source comes another wave of buying, which soon carries prices to new high levels, and purchasers congratulate themselves on their quick and easy profits.

For every buyer there must be a seller—or, more accurately, for every one hundred shares bought one hundred shares must be sold, as the actual number of _persons_ buying at this stage is likely to be much greater than the number of _persons_ selling. Early in the advance the supply of stocks is small and comes from scattered sources, but as prices rise, more and more holders become satisfied with their profits and willing to sell. The bears, also, begin to fight the advance by selling short on every quick rise. A stubborn professional bear will often be forced to cover again and again, with a small loss each time, before he finally locates the top and secures a liberal profit on the ensuing decline.

Those selling at this stage are not, as a rule, the largest holders. The largest holders are usually those whose judgment is sound enough, or whose connections are good enough, so that they have made a good deal of money; and neither a sound judgment nor the best advisers are likely to favor selling so early in the advance, when much larger profits can be secured by simply holding on.

The height to which prices can now be carried depends on the underlying conditions. If money is easy and general business prosperous a prolonged bull movement may result, while strained banking resources or depressed trade will set a definite limit to the possible advance. If conditions are bearish, the driving of the biggest shorts to cover will practically end the rise; but in a genuine bull market the advance will continue until checked by sales of stocks held for investment, which come upon the market only when prices are believed to be unduly high.

In a sense, the market is always a contest between investors and speculators. The real investor, looking chiefly to interest return, but by no means unwilling to make a profit by buying low and selling high, is ready, perhaps, to buy his favorite stock at a price which will yield him six per cent. on his investment, or to sell at a price yielding only four per cent. The speculator cares nothing about interest return. He wants to buy before prices go up and to sell short before they go down. He would as soon buy at the top of a big rise at any other time, provided prices are going still higher.

As the market advances, therefore, one investor after another sees his limit reached and his stock sold. Thus the volume of stocks to be carried or tossed from hand to hand by bullish speculators is constantly rolling up like a snowball. On the ordinary intermediate fluctuations, covering five to twenty dollars a share, these sales by investors are small compared with the speculative business. In one hundred shares of a stock selling at 150, the investor has $15,000; but with this sum the speculator can easily carry ten times that number of shares.

The reason why sales by investors are so effective is not because of the actual amount of stock thrown on the market, but because this stock is a permanent load, which will not be got rid of again until prices have suffered a severe decline. What the speculator sells he or some other trader may buy back tomorrow.

The time comes when everybody seems to be buying. Prices become confused. One stock leaps upward in a way to strike terror to the heart of the last surviving short. Another appears almost equally strong, but slips back unobtrusively when nobody is looking, like the frog jumping out of the well in the arithmetic of our boyhood. Still another churns violently in one place, like a side-wheeler stuck on a sand-bar.

Then the market gives a sudden lurch downward, as though in danger of spilling out its unwieldy contents. This is hailed as a “healthy reaction,” though it is a mystery whom it can be healthy for, unless it is the shorts. Prices recover again, with everybody happy except a few disgruntled bears, who are rightly regarded with contemptuous amusement.

Curiously, however, there seems to be stock enough for all comers, and the few cranks who have time to bother with such things notice that the general average of prices is now rising very slowly, if at all. The largest speculative holders of stocks, finding a market big enough to absorb their sales, are letting go. And there are always stocks enough to go around. Our big capitalists are seldom entirely out of stocks. They merely have more stocks when prices are low and fewer when prices are high. Moreover, long before there is any danger of the supply running out, plenty of new issues are created.

When there is a general public interest in the stock market, an immense amount of realizing will often be absorbed within three or four days or a week, after which the deluge; but if speculation is narrow, prices may remain around top figures for weeks or months, while big holdings are fed out, a few hundred shares here and a few hundred there, and even then a balance may be left to be thrown over on the ensuing decline at whatever prices can be obtained. Great speculative leaders are far from infallible. They have often sold out too soon and later have seen the market run away to unexpected heights, or have held on too long and have suffered severe losses before they could get out.

In this selling the bull leaders get a good deal of undesired help from the bears. However wary the bulls may be in concealing their sales, their machinations will be discovered by watchful professionals and shrewd chart students, and a considerable sprinkling of short sales will be put out within a few points of the top. This is one of the reasons why the long swings in active speculative stocks are smaller in proportion to price than in inactive specialties of a similar character—contrary to the generally received impression. It is rare that any considerable short interest exists in the inactive stocks.

Once the top-heavy load is overturned, the decline is usually more rapid than the previous advance. The floating supply, now greatly increased, is tossed about from one speculator to another at lower and lower prices. From time to time stocks become temporarily lodged in stubborn hands, so that part of the shorts take fright and cover, causing a sharp upturn; but so long as the load of stocks is still on the market the general course of prices must be downward.

Until investors or big speculative capitalists again come into the market, the load of stocks to be carried by ordinary speculative bulls increases almost continually. There is no lessening of the floating supply of stock certificates in the Street, and there is a gradual increase in the short interest; and of course the bulls have to carry these short sales as well as the actual certificates, since for every seller there must be a buyer, whether the sale be made by a short or a long. Shorts cover again and again on the sharp breaks, but in most cases they put out their lines again, either higher or lower, as opportunity offers. On the average, the short interest is largest at low prices, though there are likely to be periods during the decline when it will be larger than at the final bottom, where buying by shorts often helps to avert panicky conditions.

The length of this decline, like the extent of the preceding advance, depends on fundamental conditions; for both investors and speculative capitalists will come into the market sooner if all conditions are favorable than they will in a stringent money market or when the future prospects of business are unsatisfactory. As a rule, buyers do not appear in force until a “bargain day” appears. This is when, in its downward course, the heavy load of stocks strikes an area honeycombed with stop loss orders. Floor traders seize the opportunity to put out short lines and a general collapse results.

Here are plenty of stocks to be had cheap, and shrewd operators—large and small, but mostly large or on the way to become so—are busy picking them up. The fixed limits of many investors are also reached by the sharp break, and their purchases disappear, to be seen in the Street no more until the next bull turn.

Many shorts cover on such a break, but not all. The sequel to the “bargain day” is a big short interest which has overstayed its market, and a quick rally follows; but when the more urgent shorts get relief, prices sag again and fall into that condition of lethargy from which this consideration of the speculative cycle started.

The movements described are substantially uniform, whether the cycle be one covering a week, a month, or a year. The big cycle includes many intermediate movements, and these movements in turn contain smaller swings. Investors do not participate to any extent in the small swings, but otherwise the forces involved in a three-point turn up and down are substantially the same as those which appear in a thirty-point cycle, though not so easy to identify.

The fact will at once be recognized that the above description is, in essence, a story of human hopes and fears; of a mental attitude, on the part of those interested, resulting from their own position in the market, rather than from any deliberate judgment of conditions; of an unwarranted projection by the public imagination of a perceived present into an unknown though not wholly unknowable future.

Laying aside for the present the influence of fundamental conditions on prices, it is our task to trace out both the causes and the effects of these psychological elements in speculation.

FOOTNOTES:

[1] The writer discussed this subject rather fully in the _Quarterly Journal of Economics_, Vol. XVI, No. 2. The article will also be found extensively summarized and quoted in Vol. VII of “Modern Business,” edited by Joseph French Johnson, Dean of New York University School of Commerce.

II—Inverted Reasoning and its Consequences

It is hard for the average man to oppose what appears to be the general drift of public opinion. In the stock market this is perhaps harder than elsewhere; for we all realize that the prices of stocks must, in the long run, be controlled by public opinion. The point we fail to remember is that public opinion in a speculative market is measured in dollars, not in population. One man controlling one million dollars has double the weight of five hundred men with one thousand dollars each. Dollars are the horse-power of the markets—the mere number of men does not signify.

This is why the great body of opinion appears to be bullish at the top and bearish at the bottom. The multitude of small traders must be, as a plain necessity, long when prices are at the top, and short or out of the market at the bottom. The very fact that they _are_ long at the top shows that they have been supplied with stocks from some source.

Again, the man with one million dollars is a silent individual. The time when it was necessary for him to talk is past—his money now does the talking. But the one thousand men who have one thousand dollars each are conversational, fluent, verbose to the last degree; and among these smaller traders are the writers—the newspaper and news bureau men, and the manufacturers of gossip for brokerage houses.

It will be observed that the above course of reasoning leads us to the conclusion that most of those who write and talk about the market are more likely to be wrong than right, at least so far as speculative fluctuations are concerned. This is not complimentary to the “moulders of public opinion,” but most seasoned newspaper readers will agree that it is true. The press reflects, in a general way, the thoughts of the multitude, and in the stock market the multitude is necessarily, as a logical deduction from the facts of the case, likely to be bullish at high prices and bearish at low.

It has often been remarked that the average man is an optimist regarding his own enterprises and a pessimist regarding those of others. Certainly this is true of the professional trader in stocks. As a result of the reasoning outlined above, he comes habitually to expect that nearly every one else will be wrong, but is, as a rule, confident that his own analysis of the situation will prove correct. He values the opinions of a few persons whom he believes to be generally successful; but aside from these few, the greater the number of the bullish opinions he hears, the more doubtful he becomes about the wisdom of following the bull side.

This apparent contrariness of the market, although easily understood when its causes are analyzed, breeds in professional traders a peculiar sort of skepticism—leads them always to distrust the obvious and to apply a kind of inverted reasoning to almost all stock market problems. Often, in the minds of traders who are not naturally logical, this inverted reasoning assumes the most erratic and grotesque forms, and it accounts for many apparently absurd fluctuations in prices which are commonly charged to manipulation.

For example, a trader starts with this assumption: The market has had a good advance; all the small traders are bullish; somebody must have sold them the stock which they are carrying; hence the big capitalists are probably sold out or short and ready for a reaction or perhaps for a bear market. Then if a strong item of bullish news comes out—one, let us say, that really makes an important change in the situation—he says, “Ah, so this is what they have been bulling the market on! It has been discounted by the previous rise.” Or he may say, “They are putting out this bull news to sell stocks on.” He proceeds to sell out any long stocks he may have or perhaps to sell short.

His reasoning may be correct or it may not; but at any rate his selling and that of others who reason in a similar way, is likely to produce at least a temporary decline on the announcement of the good news. This decline looks absurd to the outsider and he falls back on the old explanation, “All manipulation.”

The same principle is often carried further. You will find professional traders reasoning that favorable figures on the steel industry, for example, have been concocted to enable insiders to sell their Steel; or that gloomy reports are put in circulation to facilitate accumulation. Hence they may act in direct opposition to the news and carry the market with them, for the time at least.

The less the trader knows about the fundamentals of the financial situation the more likely he is to be led astray in conclusions of this character. If he has confidence in the general strength of conditions he may be ready to accept as genuine and natural, a piece of news which he would otherwise receive with cynical skepticism and use as a basis for short sales. If he knows that fundamental conditions are unsound, he will not be so likely to interpret bad news as issued to assist in accumulation of stocks.

The same reasoning is applied to large purchases through brokers known to be associated with capitalists. In fact, in this case we often hear a double inversion, as it were. Such buying may impress the observer in three ways:

1. The “rank outsider” takes it at face value, as bullish.

2. A more experienced trader may say, “If they really wished to get the stocks they would not buy through their own brokers, but would endeavor to conceal their buying by scattering it among other houses.”

3. A still more suspicious professional may turn another mental somersault and say, “They are buying through their own brokers so as to throw us off the scent and make us think someone else is using their brokers as a blind.” By this double somersault such a trader arrives at the same conclusion as the outsider.

The reasoning of traders becomes even more complicated when large buying or selling is done openly by a big professional who is known to trade in-and-out for small profits. If he buys 50,000 shares, other traders are quite willing to sell to him and their opinion of the market is little influenced, simply because they know he may sell 50,000 the next day or even the next hour. For this reason great capitalists sometimes buy or sell through such big professional traders in order to execute their orders easily and without arousing suspicion. Hence the play of subtle intellects around big trading of this kind often becomes very elaborate.

It is to be noticed that this inverted reasoning is useful chiefly at the top or bottom of a movement, when distribution or accumulation is taking place on a large scale. A market which repeatedly refuses to respond to good news after a considerable advance is likely to be “full of stocks.” Likewise a market which will not go down on bad news is usually “bare of stocks.”

Between the extremes will be found long stretches in which capitalists have very little cause to conceal their position. Having accumulated their lines as low as possible, they are then willing to be known as the leaders of the upward movement and have every reason to be perfectly open in their buying. This condition continues until they are ready to sell. Likewise, having sold as much as they desire, they have no reason to conceal their position further, even though a subsequent decline may run for months or a year.

It is during a long upward movement that the “lamb” makes money, because he accepts facts as facts, while the professional trader is often found fighting the advance and losing heavily because of his over-development of cynicism and suspicion.

The successful trader eventually learns when to invert his natural mental processes and when to leave them in their usual position. Often he develops a sort of instinct which could scarcely be reduced to cold print. But in the hands of the tyro this form of reasoning is exceedingly dangerous, because it permits of putting an alternate construction on any event. Bull news either (1) is significant of a rising trend of prices, or (2) indicates that “they” are trying to make a market to sell on. Bad news may indicate either a genuinely bearish situation or a desire to accumulate stocks at low prices.

The inexperienced operator is therefore left very much at sea. He is playing with the professional’s edged tools and is likely to cut himself. Of what use is it for him to try to apply his reason to stock market conditions when every event may be doubly interpreted?

Indeed, it is doubtful if the professional’s distrust of the obvious is of much benefit to him in the long run. Most of us have met those deplorable mental wrecks, often found among the “chairwarmers” in brokers’ offices, whose thinking machinery seems to have become permanently demoralized as a result of continued acrobatics. They are always seeking an “ulterior motive” in everything. They credit—or debit—Morgan and Rockefeller with the smallest and meanest trickery and ascribe to them the most artful duplicity in matters which those “high financiers” wouldn’t stoop to notice. The continual reversal of the mental engine sometimes deranges its mechanism.

Probably no better general rule can be laid down than the brief one, “Stick to common sense.” Maintain a balanced, receptive mind and avoid abstruse deductions. A few further suggestions may, however, be offered:

If you already have a position in the market, do not attempt to bolster up your failing faith by resorting to intellectual subtleties in the interpretation of obvious facts. If you are long or short of the market, you are not an unprejudiced judge, and you will be greatly tempted to put such an interpretation upon current events as will coincide with your preconceived opinion. It is hardly too much to say that this is the greatest obstacle to success. The least you can do is to avoid inverted reasoning in support of your own position.

After a prolonged advance, do not call inverted reasoning to your aid in order to prove that prices are going still higher; likewise after a big break do not let your bearish deductions become too complicated. Be suspicious of bull news at high prices, and of bear news at low prices.

Bear in mind that an item of news usually causes but _one_ considerable movement of prices. If the movement takes place before the news comes out, as a result of rumors and expectations, then it is not likely to be repeated after the announcement is made; but if the movement of prices has not preceded, then the news contributes to the general strength or weakness of the situation and a movement of prices may follow.

III—“They”

If a man entirely unfamiliar with the stock market should spend several days around the Exchange listening to the conversation of all sorts of traders and investors, in order to pick up information about the causes of price movements, the probability is that the most pressing question in his mind at the end of that time would be “Who are ‘They?’”

Everywhere he went he would hear about Them. In the customers’ rooms of the fractional lot houses he would find young men trading in ten shares and arguing learnedly as to what They were to do next. Tape readers—experts and tyros alike—would tell him that They were accumulating Steel, or distributing Reading. Floor traders and members of the Exchange would whisper that they were told They were going to put the market up, or down, as the case might be. Even sedate investors might inform him that, although the situation was bearish, undoubtedly They would have to put the market temporarily higher in order to unload Their stocks.

This “They” theory of the market is quite as prevalent among successful traders as among beginners—probably more so. There may be room for argument as to why this is so, but as to the fact itself there is no doubt. Whether They are a myth or a definite reality, many persons are making money by studying the market from this point of view.

If you were to go around Wall street and ask various classes of traders who They are, you would get nearly as many different answers as the number of people interviewed. One would say, “The house of Morgan”; another, “Standard Oil and associated interests”—which is pretty broad, when you stop to think of it; another, “The big banking interests”; still another, “Professional traders on the floor”; a fifth, “Pools in the various favorite stocks, which act more or less in concert”; a sixth might say, “Shrewd and successful speculators, whoever and wherever they are”; while to the seventh, They may typify merely active traders as a whole, whom he conceives to make prices by falling over each other to buy or to sell.

Indeed, one writer of no small attainments as a student of market conditions believes that the entire phenomena of the New York stock market are under the control of some one individual, who is presumably, in some way or other, the representative of great associated interests.

It seems obviously impossible to trace to its source, tag and identify any sort of permanent controlling power. The stock markets of the world move pretty much together in the broad cyclical swings, so that such a power would have to consist of a world-wide association of great financial interests, controlling all of the principal security markets. The average observer will find it difficult to masticate and swallow this proposition.

The effort to reduce the science of speculation and investment to an impossible definiteness or an ideal simplicity is, I believe, responsible for many failures. A. S. Hardy, the diplomat, who was formerly a professor of mathematics and wrote books on quaternions, differential calculus, etc., once remarked that the study of mathematics is very poor mental discipline, because it does not cultivate the judgment. Given fixed and certain premises, your mathematician will follow them out to a correct conclusion; but in practical affairs the whole difficulty lies in selecting your premises.

So the market student of a mathematical turn of mind is always seeking a rule or a set of rules—a “sure thing” as traders put it. He would not seek such rules for succeeding in the grocery business or the lumber business; he would, on the contrary, analyze each situation as it arose and act accordingly. The stock market presents itself to my mind as a purely practical proposition. Scientific methods may be applied to any line of business, from stocks to chickens, but this is a very different thing from trying to reduce the fluctuations of the stock market to a basis of mathematical certainty.

In discussing the identity of Them, therefore, we must be content to take obvious facts as we find them without attempting to spin fine theories.

There are three senses in which this idea of “Them” has some foundation in fact. First, “They” may be and often are roughly conceived of as the floor traders on the Stock Exchange who are directly concerned in making quotations, pools formed to control certain stocks, or individual manipulators.

Floor traders exercise an important influence on the immediate movement of prices. Suppose, for example, they observe that offerings of Reading are very light. Declines do not induce liquidation and only small offerings of stock are met on advances. They begin to feel that, in the absence of unexpected cataclysms, Reading will not decline much. The natural thing for them to do is to begin buying Reading on all soft spots. Whenever a few hundred shares are offered at a bargain, floor traders snap up the stock.

As a result of this “bailing out” of the market, Reading becomes scarcer still, and traders, being now long, become more bullish. They begin to “mark up prices.” This is not difficult, since they are, for the time being, practically unanimous in a desire for higher prices. Suppose the market is 161⅛ bid, offered at 161¼. They find that only 100 shares are for sale at ¼, and 200 are offered at ⅜. As to how much stock may be awaiting bids at ½ or higher, they cannot be sure, but can generally make a shrewd guess. One or more traders take these offerings, of perhaps 500 shares, and make the market ½ bid. The other floor traders are not willing to sell at this trifling profit, and a wait ensues to see whether any outside orders are attracted by the movement of the price, and if so, whether they are buying or selling orders. If a few buying orders come in, they are filled, perhaps at ⅝ and ¾. If selling appears, the floor traders retire in good order, take the offerings at lower prices, and try it again the next day or perhaps the next hour. Eventually, by seizing every favorable opportunity, they engineer an upward move of perhaps two or three points without taking any more stock than they want.

If such a movement attracts a following, it may easily run ten points without any real change in the prospects of the Reading road—though the prospects of the road may have had something to do with making the stock scarce before the movement started. On the other hand, if large offerings of stock are encountered at the advance, the boomlet is ignominiously squelched and the floor traders make trifling profits or losses.

Pools are not so common as most outsiders believe. There are many difficulties and complications to be overcome before a pool can be formed, held together, and operated successfully, as we had ample opportunity to observe not long ago in the case of Hocking Coal & Iron. But if a definite pool exists in any stock, its operations are practically a reproduction, on a larger scale and under a binding agreement, of the methods employed by floor traders over a smaller range and in a mere loose and voluntary association resulting from their common interests. And the individual manipulator is only a pool consisting of one person.

Second, many conceive “Them” as an association of powerful capitalists who are running a campaign in all the important speculative stocks simultaneously. It is safe to say that no such permanent and united association exists, though it would be hard to prove such a statement. But there have been many times when a single great interest was practically in control of the market for a time, other interests being content to look on, or to participate in a small way, or to await a favorable chance to take the other side.

The “Standard Oil crowd,” the “Gates crowd,” the “Morgan interests,” and Harriman and his associates, will at once occur to the reader as having been, at various times in the past, in sole control of an important general campaign. At present the great interests are generally classified into three divisions—Morgan, Standard Oil, and Kuhn-Loeb.

A definite agreement among such interests as these would be impossible, except for limited and temporary purposes. This is perhaps not so much because these high financiers couldn’t trust each other, as it is because each so-called interest consists of a loosely bound aggregation of followers of all sorts and varieties, having only one thing in common—control of capital. Such an “interest” is not an army, where the traitor can be court-martialed and shot; it is a mob, and has to be led, not driven. True, the known traitor might be put to death, financially speaking, but in stock market operations the traitor cannot, as a rule, be known. Unless his operations are of unusual size, he can successfully cover his tracks.

From this second point of view, “They” are not always active in the market. Great campaigns can only be undertaken with safety in periods when the future is to a certain extent assured. When the future is in doubt, when various confusing elements enter into the financial and political situation, leading financiers may be quite content to confine their stock market operations to individual deals, and to postpone the inauguration of a broad campaign until a more solid foundation exists for it.

Third, “They” may be conceived simply as speculators and investors in general—all that miscellaneous and heterogeneous troop of persons, scattered over the whole world, each of whom contributes his mite to the fluctuations of prices on the Stock Exchange. In this sense there is no doubt about the existence of Them, and They are the court of last resort in the establishment of prices. To put it another way, these are the “They” who are the ultimate consumers of securities. It is to Them that everybody else is planning, sooner or later, directly or indirectly, to sell his stocks.

You can lead the horse to water, but you can’t make him drink. You or I or any other great millionaire can put up prices, but you can’t make Them buy the stocks from you, unless They have the purchasing power and the purchasing disposition. So there is no doubt that here, at any rate, we have a conception of Them which will stand analysis without exploding.

In cases where a general campaign is being conducted, the “They” theory of values is of considerable help in the accumulation or distribution of stocks. In fact, in the late stages of a bull campaign the argument most frequently heard is likely to be something as follows: “Yes, prices are high and I can’t see that future prospects are especially bullish—but stocks are in strong hands and They will have to put them higher to make a market to sell on.” Some investors make a point of dumping over all their stocks as soon as this veteran war-horse of the news brigade is groomed and trotted out. Likewise, after a prolonged bear campaign, we hear that somebody is “in trouble” and that They are going to break the market until certain concentrated holdings are brought out.

All this is very likely to be nothing but dust thrown in the eyes of that most gullible of all created beings—the haphazard speculator. When prices are so high in comparison with conditions that no sound reason can be advanced why they should go higher, a certain number of people are still induced to buy because of what They are going to do. Or, at least, if the public can no longer be induced to buy in any large volume, it is prevented from selling short for fear of what They may do.

The close student of the technical condition of the market—by which is meant the character of the long and short interests from day to day—is pretty sure to base his operations to a considerable extent on what he thinks They will do next. He has in mind Them as described in the first classification above—floor traders, pools and manipulators. He gets a good deal of help from this conception, crude as it may appear to be—largely, no doubt, because it serves to distract his mind from current news and gossip, and to prevent him from being too greatly influenced by the momentary appearance of the market.

When the market looks weakest, when the news is at the worst, when bearish prognostications are most general, is the time to buy, as every schoolboy knows; but if a man has in mind a picture of a flood of stocks pouring out from the four quarters of the globe, with no buyers, because of some desperately bad news which is just coming over the ticker, it is almost a mental impossibility for him to get up the courage to plunge in and buy. If, on the other hand, he conceives that They are just giving the market a final smash to facilitate covering a gigantic line of short stocks, he has courage to buy. His view may be right or wrong, but at least he avoids buying at the top and selling at the bottom, and he has nerve to buy a weak market and sell a strong one.

The reason for the haziness of the “They” conception in the average trader’s mind is that he is only concerned with Them as They manifest Themselves through the stock market. As to who They are he feels a mild and detached curiosity; but as to Their manifestations in the market he is vitally and financially interested. It is on the latter point, therefore, that he concentrates his thoughts.

But inasmuch as definite, painstaking analysis of a situation is always better than a hazy general notion of it, the trader or investor would do much better to rid his mind of Them. The word “They” means nothing until it has an antecedent; and to use it continually without having any antecedent in mind is slipshod language, which stands for slipshod thinking. They, in the sense of the big banking interests, may be working directly against Them in the sense of individual manipulators; the manipulator, again, may be trying to trap Them in the sense of floor traders.

A genuine knowledge of the technical condition of the market cannot be summed up in any offhand declaration about what They are going to do. You cannot determine the attitude toward the market of every individual who is interested in it, but you can roughly classify the sources from which buying and selling are likely to come, the motives which are likely to actuate the various classes, and the character of the long interest and short interest. In brief, after enough study and observation, you can always have in mind some kind of an antecedent for Them, and must have it, if you base your operations on technical conditions.

IV—Confusing the Present with the Future—Discounting

It is axiomatic that inexperienced traders and investors, and indeed a majority of the more experienced as well, are continually trying to speculate on past events. Suppose, for example, railroad earnings as published are showing constant large increases in net. The novice reasons, “Increased earnings mean increased amounts applicable to the payment of dividends. Prices should rise. I will buy.”

Not at all. He should say, “Prices _have risen_ to the extent represented by these increased earnings, unless this effect has been counterbalanced by other considerations. Now what next?”

It is a sort of automatic assumption of the human mind that present conditions will continue, and our whole scheme of life is necessarily based to a great degree on this assumption. When the price of wheat is high farmers increase their acreage because wheat-growing pays better; when it is low they plant less. I remember talking with a potato-raiser who claimed that he had made a good deal of money by simply reversing the above custom. When potatoes were low he had planted liberally; when high he had cut down his acreage—because he reasoned that other farmers would do just the opposite.

The average man is not blessed—or cursed, however you may look at it—with an analytical mind. We see “as through a glass darkly.” Our ideas are always enveloped in a haze and our reasoning powers work in a rut from which we find it painful if not impossible to escape. Many of our emotions and some of our acts are merely automatic responses to external stimuli. Wonderful as is the development of the human brain, it originated as an enlarged ganglion, and its first response is still practically that of the ganglion.

A simple illustration of this is found in the enmity we all feel toward the alarm clock which arouses us in the morning. We have carefully set and wound that alarm and if it failed to go off it would perhaps put us to serious inconvenience; yet we reward the faithful clock with anathemas.

When a subway train is delayed nine-tenths of the people waiting on the platforms are anxiously craning their necks to see if it is coming, while many persons on it who are in danger of missing an engagement are holding themselves tense, apparently in the effort to help the train along. As a rule we apply more well-meant, but to a great extent ineffective, energy, physical or nervous, to the accomplishment of an object, than analysis or calculation.

When it comes to so complicated a matter as the price of stocks, our haziness increases in proportion to the difficulty of the subject and our ignorance of it. From reading, observation and conversation we imbibe a miscellaneous assortment of ideas from which we conclude that the situation is bullish or bearish. The very form of the expression “the situation is bullish”—not “the situation will soon become bullish”—shows the extent to which we allow the present to obscure the future in the formation of our judgment.

Catch any trader and pin him down to it and he will readily admit that the logical moment for the highest prices is when the news is most bullish; yet you will find him buying stocks on this news after it comes out—if not at the moment, at any rate “on a reaction.”

Most coming events cast their shadows before, and it is on this that intelligent speculation must be based. The movement of prices in anticipation of such an event is called “discounting,” and this process of discounting is worthy a little careful examination.

The first point to be borne in mind is that some events cannot be discounted, even by the supposed omniscience of the great banking interests—which is in point of fact, more than half imaginary. The San Francisco earthquake is the standard example of an event which could not be foreseen and therefore could not be discounted; but an event does not have to be purely an “act of God” to be undiscountable. There can be no question that our great bankers have been as much in the dark in regard to some recent Supreme Court decisions as the smallest “piker” in the customers’ room of an odd-lot brokerage house.

If the effect of an event does not make itself felt before the event takes place, it must come after. In all discussion of discounting we must bear this fact in mind in order that our subject may not run away with us.

On the other hand an event may sometimes be overdiscounted. If the dividend rate on a stock is to be raised from four to five per cent., earnest bulls, with an eye to their own commitments, may spread rumors of six or seven per cent., so that the actual declaration of five per cent. may be received as disappointing and cause a decline.

Generally speaking, every event which is under the control of capitalists associated with the property, or any financial condition which is subject to the management of combined banking interests, is likely to be pretty thoroughly discounted before it occurs. There is never any lack of capital to take advantage of a sure thing, even though it may be known in advance to only a few persons.

The extent to which future business conditions are known to “insiders” is, however, usually overestimated. So much depends, especially in America, upon the size of the crops, the temper of the people, and the policies adopted by leading politicians, that the future of business becomes a very complicated problem. No power can drive the American people. Any control over their action has to be exercised by cajolery or by devious and circuitous methods.

Moreover, public opinion is becoming more volatile and changeable year by year, owing to the quicker spread of information and the rapid multiplication of the reading public. One can easily imagine that some of our older financiers must be saying to themselves, “If I had only had my present capital in 1870, or else had the conditions of 1870 to work on today!”

A fair idea of when the discounting process will be completed may usually be formed by studying conditions from every angle. The great question is, when will the buying or selling become most general and urgent? In 1907, for example, the safest and best time to buy the sound dividend-paying stocks was on the Monday following the bank statement which showed the greatest decrease in reserves. The markets opened down several points under pressure of liquidation, and standard issues never sold so low afterward. The simple explanation was that conditions had become so bad that they could not get any worse without utter ruin, which all parties must and did unite to prevent.

Likewise in the Presidential campaign of 1900, the lowest prices were made on Bryan’s nomination. Everyone said at once, “He can’t be elected.” Therefore his nomination was the worst that could happen—the point of time where the political news became most intensely bearish. As the campaign developed his defeat became more and more certain, and prices continued to rise in accordance with the general economic and financial conditions of the period.

It is not the discounting of an event thus known in advance to capitalists, that presents the greatest difficulties, but cases where considerable uncertainty exists, so that even the clearest mind and the most accurate information can result only in a balancing of probabilities, with the scale perhaps inclined to a greater or less degree in one direction or the other.

In some cases the uncertainty which precedes such an event is more depressing than the worst that can happen afterward. An example is a Supreme Court decision upon a previously undetermined public policy which has kept business men so much in the dark that they feared to go ahead with any important plans. This was the case at the time of the Northern Securities decision in 1904. “Big business” could easily enough adjust itself to either result. It was the uncertainty that was bearish. Hence the decision was practically discounted in advance, no matter what it might prove to be.

This was not true to the same extent of the Standard Oil and American Tobacco decisions of 1911, because those decisions were an earnest of more trouble to come. The decisions were greeted by a temporary spurt of activity, based on the theory that the removal of uncertainty was the important thing; but a sensational decline started soon after and was not checked until the announcement that the Government would prosecute the United States Steel Corporation. This was deemed the worst that could happen for some time to come, and was followed by a considerable advance.

More commonly, when an event is uncertain the market estimates the chances with considerable nicety. Each trader backs his own opinion, strongly if he feels confident, moderately if he still has a few doubts which he cannot down. The result of these opposing views may be stationary prices, or a market fluctuating nervously within a narrow range, or a movement in either direction, greater or smaller in proportion to the more or less emphatic preponderance of the buying or selling.