Buy the Book: G.C. Selden’s timeless book describes the influence human nature has on markets and what investors/traders must do to overcome potential behavioral errors to be successful. It’s as relevant today as it was when it was published in 1912.
The Notes
- “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.”
- The long term movement in prices is due to changing financial conditions. Short term movements are due to the changing state of the public’s mind.
- Two views on the psychology of speculation:
- What effect do different public attitudes have on price movements? How is the market influenced by these psychological conditions?
- How does a trader’s changing attitudes affect their chance of success? How can a trader overcome the self-imposed obstacles created through hope, fear, timidity, and obstinance?
- “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.”
- Steps in the Speculative Cycle:
- It starts with prices rising without much notice — small fluctuations, slight public interest, low volume, some short interest. It’s thought to be temporary so a few speculate on a turn. Selling brings prices almost back to the previous low.
- Another upward move pushes prices higher than the first — a few shrewd traders bet on the long side, the public still stays out.
- Prices advance sharply — timid shorts cover, talk of a bull turn spreads, more traders bet the long side, the public notices higher prices but waits for a better buying opportunity. The “better opportunity” never comes or its misread as market weakness.
- The market “boils” — stubborn bears cover, the public finally sees a time to “buy ’em anywhere,” any price will do, which pushes prices higher. Buyers outnumber sellers. The height of prices and length of advance is dependent on the easy availability of money and general business prosperity. Tensions in either will limit higher prices and raise the chance of higher selling.
- Everybody is buying — chaos takes over prices.
- A sudden lurch downward — its seen as a “healthy reaction,” prices recover, bears are looked at with amusement.
- There’s more than enough supply of shares to go around — new shares are issued, new IPOs hit the market, bears who got out too soon climb back in, the rise in prices slows or stalls.
- The decline is rapid — the increased supply of shares far exceeds demand, a rise in short sales add to the supply. “The market is always a contest between investors and speculators.” As the market rises, investors gradually sell, adding to the volume of stock trading between speculators. For prices to continue to rise, speculators must increase in numbers and/or place larger bets. Eventually, the investor’s sales lead to a volume that acts like a “permanent load” that won’t diminish until prices decline sharply enough to bought by investors, by big speculators taking long positions again, or by shorts covering.
- “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.”
- “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.”
- “It has been remarked that the average man is an optimist regarding his own enterprises and a pessimist regarding those of others.”
- “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.”
- Beware of news about what They are doing: bull news could mean a further rise in prices or that They hope to sell at a higher price, and bad news could be a bearish sign or They want to buy at lower prices.
- “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.”
- Having a position in the market brings with it a bias favoring a profitable direction for that position. Any news will be interpreted based on that preconceived bias.
- After a long bull market, it’s natural to think prices will continue to go higher. The same goes for still lower prices after the market has fallen.
- “Be suspicious of bull news at high prices, and of bear news at low prices.”
- Any big news typically causes one move in prices. If prices move on a rumor, they’re less likely to move again when the news is officially announced.
- Trying to reduce investing or speculating to a mathematical certainty will lead to failure. No rules or set of rules will guarantee a “sure thing.”
- “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.”
- Inexperienced — even some experienced — investors and traders continually speculate on past events. They fail to consider that what’s happened is already priced in and should ask, “What’s 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.”
- Most of our emotions are natural, automatic responses to external stimuli that don’t always translate well to investing.
- On discounting future events:
- Some events can’t be discounted — things like natural disasters, major court decisions.
- If the event is not already priced in before it happens, it will be priced in after.
- Some events can be over discounted — the event turned out to be less good or less bad than the market expected.
- Some events can be under discounted — turned out much better or worse than the market expected.
- The idea that some event is known to “insiders” is overestimated — too many variables for a small group to control for like market behavior, political policies, public opinion, the rapid spread of information.
- Think in probabilities, allow for uncertainty — “It’s 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 scale perhaps inclined to a greater or less degree in one direction or the other.”
- Sometimes the uncertainty surrounding an event is worse than the worst case scenario.
- “In this matter of discounting, as in connection with most other stock market phenomena, the most useful hint that can be given is to avoid all efforts to reduce the movement of prices to rules, measures, or similarities and to analyze each case by itself. Historical parallels are likely to be misleading. Every situation is new, though usually composed of familiar elements. Each element must be weighed by itself and the probable result of the combination estimated. In most cases, the problem is by no means impossible, but the student must learn to look into the future and to consider the present only as a guide to the future. Extreme prices will come at the time when the news is most emphatic and most widely disseminated. When that point is passed the question must always be, ‘What next?'”
- “Not only probabilities but even rather remote possibilities are reflected in the market. Hardly any event can happen of sufficient importance to attract general attention which some process of reasoning cannot construe as bullish and some other process interpret as bearish.”
- Avoid making decisions based on “what others may do.” It eliminates independent thinking and common sense. Besides, following “what others may do” lowers the chance of making a profit.
- The hardest part of investing is keeping an unbiased, balanced perspective regardless of the positions held because hopes, fears, etc. can unconsciously weigh on decisions.
- “As a rule, we can find plenty of reasons for doing what we very much want to do, and we are still more prolific with excuses for not doing what we don’t want to do. Most of us change the old sophism “Whatever is, is right” to the more directly useful form “Whatever I want is right.””
- The market doesn’t care what you own or what you expect from it: “The market is relentless. It cannot be budged by our sophistries. It will respond exactly to the forces and personalities which are working upon it, with no more regard for our opinions than if we couldn’t vote.”
- We are biased to our own interests. The risk is becoming so focused on your positions, that you become blind to anything that falls outside your biased opinion. Being able to keep an open mind, independent of market direction, offers the best chance of success.
- “Not one trader in a thousand ever becomes so expert or so seasoned as to entirely overcome the influence his position in the market exerts upon his judgment. That influence appears in the most insidious and elusive ways. One of the principal difficulties of the expert is in preventing his active imagination from causing him to see what he is looking for just because he is looking for it.”
- “It is a sort of proverb in Wall Street that there is no bear so bearish as a soldout bull who wants a chance to repurchase.”
- The market is not overcome by a sudden flash of fear at the lows in a panic. Fear creeps in at the peak. Cautious investors fear getting out too late, so they sell on that feeling. In the decline, uneasiness and caution spreads, increasing in waves. The bottom of a panic happens out of necessity — forced sales due to exhausted resources — because the people most likely to sell out fear did so long before the bottom was in sight.
- “The great cause of loss in times of panic is the failure of the investor to keep enough of his capital in liquid form… This condition, in turn, results from trying to do too much — greed, haste, excessive ambition, an oversupply of easy confidence as to the future.”
- The other side of fear is an unwillingness to buy. Unwilling buyers are equally at fault as sellers for falling prices in a panicky market.
- “It takes far less uneasiness to cause the intending investor to delay purchases than to precipitate actual sales by holders.”
- The boom is almost the reverse of the panic. “Confidence and enthusiasm keep reproducing each other on a wider and wider scale until the result is a sort of hilarity on the part of thousands of men, many of them comparatively young and inexperienced, who have “made big money” during the long advance in prices.”
- It’s harder to predict the end of a boom than the end of a panic.
- Keynes’s beauty contest — “Erratic fluctuations are the result of the efforts of traders to operate, not on the basis of facts, nor on their own judgment as to the effect of facts on prices, but on what they believe will be the probable effect of facts or rumors on the minds of other traders. This mental attitude opens up a broad field of conjecture, which is not limited by any definite boundaries of fact or common sense.”
- Unsuccessful Mental Attitudes of a Trader:
- Over-Optimism: “As a general thing optimism includes the persistent nourishing of hope, an aggressive confidence, the certainty that you are right, a firm determination to accomplish your end. But you cannot make the stock market move your way by believing that it will do so.”
- Enthusiasm: “The moment you permit yourself to become enthusiastic, you are subordinating your reasoning powers to your beliefs or desires.”
- Stubbornness: “The trouble arises in drawing the line between, on the one hand, persistence, consistence, pursuit of a definite plan until conditions change; and, on the other, stubborn adherence to a course of action which subsequent events have proved to be erroneous.”
- Getting a Notion: Results from a failure to see the big picture of a situation and key in on one idea, as if it’s certain to affect markets, and ignore everything else.
- Getting a Hunch: an extreme form of a notion. “This term appears to mean, when it means anything, a sort of sudden welling up of instinct so strong as to induce the trader to follow it regardless of reason… The novice, or the man who is not closely in touch with technical conditions, is merely making an unusual ass of himself when he talks about a ‘hunch.'”
- Being Hasty: “do not act hastily on apparently sensational information; do not trade so heavily as to become anxious; and do not permit yourself to be influenced by your position in the market.”
- “Any emotion — enthusiasm, fear, anger, depression — will only cloud the intellect.”
- “We can point out the errors to be avoided much more successfully than we can lay out a course of positive action.”
- “The greatest fault of ninety-nine out of one hundred active traders is being bullish at high prices and bearish at low prices. Therefore, refuse to follow the market beyond what you consider a reasonable climax, no matter how large the possible profits that you may appear to be losing by inaction.”
