Part 2

Although a beginner in practice, he was a veteran in theory, for prior to entering the financial arena he had made hundreds of imaginary purchases and sales, nearly always at a profit. Moreover he had discovered that one may play both sides of the market, apparently with equal safety, and that the biggest “killings” are said to be made on the “short” side. By selling “short” on bulges and “covering” (i. e., buying the stock in to cover the sale) on reactions, it was possible not only to make money both ways, but also to avoid the tedium of waiting inertly for opportune occasions to buy at bargain-prices. From the experience of others he derived a valuable lesson, namely, that investors and traders are always too eager to keep their capital constantly employed; that they are prone to hold stubbornly to one position, either long or short; and that the wellnigh irresistible impulse to get back into the market after selling out, whether at a profit or a loss, has probably been the ruination of more speculators than any other one cause. Playing the market both ways seemed a sure means of forestalling this error.

STOCK MARKET TRANSACTIONS APART FROM GAMBLING

The thought of becoming a stock “gambler” was farthest from this man’s mind; for gambling in any form was contrary to his code of ethics. But buying and selling legitimate commodities could not be construed as gambling; therefore stocks and bonds, being legitimate commodities, could be bought and sold without doing violence to the most sensitive conscience. In order to gamble, one must “risk or stake something on an uncertain event;” which is popularly regarded as a vice, and is made legally wrong because it is said to be injurious to the public morals. It also is morally wrong to gamble, because if you win you deprive your fellow-being of something without giving any adequate return. Our friend contended that stocks bought at figures below their intrinsic value are so sure to advance, that the transaction does not come within the given definition of the word _gamble_; also that the same rule applies to stocks sold at prices far above their worth, no matter whether for long or short account. He reasoned that if he gained by selling a stock short, although someone was apt to be the loser, he had no means of knowing who that someone was, therefore he assumed no moral responsibility in prudently acquiring money in a businesslike way, even at the expense of some indefinite person who had been foolish enough to risk it. If the act of selling stocks which one does not own is regarded by some as being unethical in the strictest sense, it is at least sanctioned by general custom. All sorts of goods are sold for future delivery, even before they are manufactured; and our erstwhile merchant had often sold leather for forward delivery, while it was still in process of tanning; hence he had no scruples against selling stocks in anticipation of being able to buy and deliver them later.

It is generally conceded that the public is always arrayed on the “long” side (that is, the buying side) of the market; it is also universally admitted, at least by those who know, that the so-called “public” always bears the brunt of stock market losses; therefore our friend decided that he would act the part of wisdom and go “short” of the same number of shares that he had previously bought and sold,--the idea being that before selling his long stock he convinced himself that approximately the top prices had been reached, in which case the market would naturally react. But for some inexplicable reason it failed to run true to his expectations; that is, the probable course deducible from charts and precedents. Per contra, the prices continued stubbornly to rise. When he had lost all his profits he backed his judgment by his actions, and doubled his short sales; and at five points higher he doubled again, for a break was long overdue. Being short upwards of three thousand shares in a rapidly rising market is a tremendous mental strain, even for a seasoned trader; and naturally our novice became somewhat nervous. Some stock market wiseacre--one or more of which class are usually to be found lounging about every brokerage office--consolingly remarked that while stocks have a certain fixed bottom, they have no top; which increased his anxiety.

After studying charts and various compilations of figures and facts about earnings and past market performances, he concluded that Bethlehem Steel, selling at $45 a share, was not worth half that price; also that Studebaker at $35 was much too high. After an extended inquiry into the past and prospective earnings of these two companies he sold short a thousand shares of each; but instead of reacting they steadily maintained their upward course with the rest of the list. His broker called for more margin, and he put up another hundred thousand in bonds. He was advised to “cover” and go “long,” but he stood firmly by his convictions--and the charts.

“That’s why the public all lose,” he declared; “they get ‘cold feet’ and shift positions at the wrong time.” From a personal friend who was a director of the new General Motors Corporation he got an “inside tip” that that stock, selling at $82, was too high, so he added a few hundred shares of it to his short account. Meantime the country’s commerce and the entire group of stocks, moved forward with the steady even tread of an army on parade.

THE STOCK MARKET PRODUCES A NEW PHENOMENON--TURNS WORLD-WIDE DISASTER INTO LOCAL PROSPERITY

At this time (1915) the major portion of the civilized world was embroiled in a mad turmoil, employing every known device and resource in destroying human life and every form of physical property. With the very foundations of civilization thus disrupted, and our own country on the verge of being drawn into a deadly combat in which the most humane and enlightened nations of the earth were reverting to the practices of ancient barbarism, it is not strange that our merchant friend should have argued that it was a most unpromising situation upon which to construct investment values and business prosperity. It was inconsistent, inconceivable and seemingly impossible that stocks, even good stocks, could continue to advance in the face of such demoralizing conditions. When war was first declared, even before England became involved, the stock market was thrown into such a violent state of panic that it became necessary to close the stock exchange for several months; yet now when the clouds of disaster were at their darkest and hung menacingly over the whole of civilization this country alone was indulging in a riotous exhibition of prosperity such as had never been dreamed of. The market tipsters, the financial editors of newspapers, the brokers’ letters and all stock market literature, with but few exceptions, were crowing loud and boastfully for still higher prices, and after the whole group of stocks had risen in unison for a time, some individual stock was singled out every day or so, pushed into the forefront and skyrocketed to dizzying heights. The brokers and all the customers were delirious with joy and excitement. The stock brokers were all bulls, the traders were bulls, the tipsters and rumor-mongers were bulls--even the office boys who called the quotations from the tickers were bulls, and shouted vociferously when some special stock jumped a point or more from the previous quotation; and it seemed to our trader that in calling out the advancing prices special emphasis was always given to the particular stocks he was short of. He was literally beset with bullish exultation and bullish news from everywhere. The noisy enthusiasm in the board-room rankled in his ears and rasped on his over-wrought nerves. He felt as one could imagine a tiny lone bear would feel in the center of a great arena, surrounded by a cordon of cavorting bulls. To him it seemed that he was the only bear on earth. There might be others, but they were too cleverly sequestered to admit of sharing his misery with them.

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NOBODY LOVES A BEAR

In a bear market a discouraged bull is at least not despised; he may find a sympathetic sufferer; but in a bull market no one ever wastes any compassion on a bear, or admits sympathetic kinship with him. He is popularly regarded as a pessimist, a destroyer of values, a discordant note, an uninvited guest at a banquet. If it be a true saying that “misery loves company,” it must follow that wretchedness is accentuated by noncommunion with fellow-sufferers; in which case it may be said that the situation of a bear in a rousing bull market represents the _ne plus ultra_ of hopeless desolation.

At length it became a mooted question whether to “sit tight” and wait for the boisterous storm to blow over, or cover his shorts, buy more stocks and go with the tide. Heretofore he had maintained a stolid attitude, born of self-confidence, inspired by a triumphant business career, and supported by precedent and every reasonable prophecy. The traders had simply gone mad and were rushing headlong to their ruin, as they had often done before. History was merely repeating itself. It was a time for sound cool-headed judgment, and he stood firm in the determination not to lose his head and join in any such reckless carousal. But the more he reasoned and studied the charts, the more unprecedented and obstinate the market became. One thing he failed to consider was, that the favorite caprice of the stock market is to violate precedent, and to do the thing least to be expected of it. The newspapers gave front page double-column headings to business improvement and stock market news--the enormous demand for textiles, increased prices for all commodities, easy money conditions, all labor disputes amicably adjusted, and the stage all set for the greatest era of prosperity the world had ever known. The financial columns of the newspapers literally teemed with bullish interviews with financiers and bullish reports in all lines of trade and finance. There was scarcely a discordant note in the rush and rhythm of progress; and when one was faintly sounded the general din instantly smothered it. Even the great cataclysm in Europe was now construed as an additional bull point, because our factories were all running night and day to supply the armies with equipment and provisions. It was argued that the more they fought the more supplies they would need, and the more money we would make in furnishing them; also that the more ships the Germans torpedoed the greater demand there would be upon our shipyards to replace them. The nation had indeed gone prosperity mad, while the rest of the world was going to destruction--certainly an irregular and puzzling phenomenon. Occasionally when some veteran writer piped a note of warning to stock speculators, it was met with a new outburst of bullish demonstration, and the market swept on like a conflagration in a city built of tinderwood. Stocks that had lain dormant for months suddenly came to life and became the favorites of powerful cliques; corporations that had never earned their fixed charges were said to be piling up enormous surpluses, the railroads and steamship lines were glutted with traffic, the factories, steel foundries and ammunition plants were running night shifts, banks and millionaires were said to be buying everything for control, whole fleets of grain-laden ships were going abroad and the farmers were simply wallowing in wealth; the retail stores were jammed with eager customers, labor was all employed at high wages, and Big Business was rushing with all the force of an avalanche along Prosperity Highway, without a danger signal in sight.

Gradually, though manifestly, it became evident that to resist such a tremendous momentum was as expensive as it was exasperating; and his hitherto fond illusions of greater wealth were dispelled by a terrifying reality. But a man who has been right all his life is not easily convinced that he is wrong in a market position that seems justified by common sense and fundamental conditions. And yet, however steadfast human resolution may be, it is wellnigh impossible to maintain a fixed attitude in opposition to such a cumulative and overwhelming force. The sensation of being short in a rampant bull market has been pictured as similar to that of being chained by the heels to a rising balloon, without any idea of the height to which the gas will carry it--not a cheery picture for the contemplation of one who is bearishly disposed. It is therefore easy to understand how likely one is under these “third degree” operations to lose his mental bearings, his nerve--and his money. A trader who is long of stocks knows to a certainty how much he can lose on any given number of shares; but on the short side there is no limit to what one may lose, even on a few hundred shares. The loss of a definite sum, whatever the amount may be, can be borne with equanimity by a man of nerve; but to maintain a short position in a bull market gives one about as uneasy a feeling as it would to have a number of outstanding promissory notes with the amounts left blank for some unknown person to fill in. It keeps one in a constant state of fear, and fear knows no limitations; it contemplates and magnifies every baneful possibility.

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However, this man of iron nerve, this erstwhile dominant figure in the leather trade who had ridden for a quarter of a century with his feet firmly in the stirrups, was not to be easily unhorsed. At the close of a turbulent day he took account of stock and decided to “cover” (buy in) all the dividend paying stocks he was short of, and to sell an equal number of additional shares in the non-dividend paying issues, such as Bethlehem Steel, General Motors and Studebaker. The reckoning showed a paper loss of a quarter of his million dollar capital, but he bore it courageously, determined to recover it by adopting the safer course of “shorting” only such stocks as had never paid dividends, and perhaps never would. Therefore he sold more Bethlehem Steel, at $80, $90, $100, $150 and $200 a share. He sold Studebaker again at $75, $100 and $150, and more General Motors at $100, $150, $200; and a hundred shares at every fifty points advance until it reached $500. Those who knew him in the board room said that throughout this ordeal he maintained the most inflexible nerve they had ever known; but at the close of the market on that memorable day in 1915 when Bethlehem Steel touched $600 a share he collapsed in a state of nervous prostration and was taken home in an ambulance. He did not live to see General Motors sell at $850 a share (on October 25, 1916) and Bethlehem Steel at $700 a share (on November 18, 1916). Long before these figures were reached his million dollar capital had vanished and he had crossed the bar into the Great Beyond. His widow was left almost penniless and he was buried at the expense of his Lodge. Shortly before passing away he remarked sorrowfully to a friend at the bedside,--“In the past year I’ve suffered every torment known to the demons of hell. My only grain of comfort is that it’s all over now and I have nothing more to lose.”

From this tragic experience it is obvious that there is but little comfort or profit to be gained on the short side of a protracted bull market; and the natural inference must be that the “long” side of such a market is as felicitous and profitable for bulls as the short side is discomforting and unprofitable for bears. In theory it is, but in practice there are comparatively few who make large gains, and fewer still who “get away” with them. It has been authoritatively stated by the head of the world’s largest gambling emporium that it is impossible for any human being to beat the roulette wheel for any considerable length of time; and that human nature is so constituted that nearly all of those who make large winnings continue to play until they have lost all their gains, and perhaps more. In the first place, there are thirty-six numbers, with a single and double zero,[1] on the wheel; if a player places a dollar on each of these he stakes $38. He must inevitably win on some one of the numbers or one of the zeros, whereupon he collects $35, together with the dollar risked on the successful number, making a sure loss of two dollars, which is the house’s fixed percentage. If a player wagers a dollar on one number, with an even break of luck he is due to win $35 (and also to get his dollar back) once in thirty-eight plays. At this rate, for every $3800 risked he is due to lose $200. Players often stake as high as two to three thousand dollars, or even more, on every spin of the wheel; from which it will be seen that with average luck, at this rate of play one will lose more than a thousand dollars an hour. It is said to be a proven fact that the chances are so much against the player, that a roulette wheel can be run at a profit, even if the percentage in favor of the house is entirely eliminated. This is due to the fact that the excitement of play causes a certain confusion of mind, and players are prone to do the wrong thing; for instance, double their bets when in an adverse run of luck and “pinch” them when luck is running favorably. Or, on the other hand, players who have pressed their advantage and doubled in a run of favorable luck will continue stubbornly to plunge long after their luck has changed. Precisely the same psychology applies to trading in stocks.

FOOTNOTE:

[1] At Monte Carlo the roulette wheels have only one cipher, but at the end of each turn of the wheel the person (or persons) playing on the winning number usually contributes a disk (or one thirty-fifth of the amount won) to the croupier’s “box,” which amounts to about the same thing as having two ciphers, without this customary gratuity. It is said that one-half of the amount of these voluntary contributions goes to the corporation, and the other half pays for the entire upkeep of the establishment, including the salaries of the croupiers and other attaches. The same disks are used by all players, and a winner who persistently ignores the “box” is not apt to be favored by the croupier when another player claims his winning bet, as often happens.

FRENZIED SPECULATION IS THE RANKEST FORM OF GAMBLING; IT IS A PERILOUS INDULGENCE

An enormous percentage of stock market speculators become victims of over-confidence after a series of successful trades. Their buoyant spirits increase with every new success, until at length they throw discretion to the winds, extend their risks far beyond the margin of safety, and at the infallible turn of the market they find themselves in difficulty, like foolish fishes that get stranded on the beach at high tide. It is a fact, as inexplicable as it is true, that men with a fair amount of gray matter in their heads, who would flout the idea of paying $50 a share for a particular stock, will later borrow money from a broker at from six to eight per cent. to buy the same stock all the way up from $100 to $150 a share on the slenderest permissible margin; and, instead of proportioning the margin of safety to the increased carrying risk they narrow it by continuing to buy as the prices advance. Also there are many who after selling their stocks at a handsome profit will buy them back at twenty, fifty, eighty, or a hundred points higher, and with much less timidity than they felt when they first bought them at low figures. Prosperity in the stock market seems to encourage optimism, rashness and impatience in about the same degree that adversity discourages enterprise and aspiration. But there is far greater danger in excessive optimism than in excessive pessimism, for the reason that optimists are inclined to back their hopeful views by indiscriminate purchases of stocks at high prices, while pessimists are seldom disposed to back their views at all. The risks incurred in buying stocks on a “thin” margin are so manifest that it seems almost as platitudinous to mention them as it would be to remark that children endanger their lives when they congregate on thin ice.

THE DANGERS OF INVERTED PYRAMIDS

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