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Psychology of the Stock Market

by George C. Selden


This book was written back in 1912 and is still extremely relevant to the stock and other markets today. It’s only 100 or so pages long but the wisdom within is profound and ahead of its time.


“movements of prices on the exchanges are dependent to a very considerable degree on the mental attitude of the investing and trading public.”

In a sense, the market is always a contest between investors and speculators. Investors look chiefly to interest (yield) return, however, are still willing to sell high if they managed to buy low.


The speculator on the other hand cares nothing about interest return. He wants to buy before prices go up and sell short before they go down. He would as soon buy at the top of a big rise provided they were still to go higher.

Sales by investors are small compared to speculative business. In 100 shares of stock selling at 150, the investor has $15,000, but with this sum, the speculator can carry 10x that number of shares.


Sales by investors are quite effective, however, as the stock is a permanent load which will not be got rid of again until prices have suffered a severe decline. What the speculative sells, he or some other trader may buy back tomorrow.


As the market advances, 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. The time comes when everybody seems to be buying. Prices become confused. 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 regarded with contemptuous amusement. There seems to be stock for everyone but prices are rising slower than before, if at all. The largest speculative holders of stocks let their sales go(being careful not to crash the market before they unload). If there was a lot of public interest involved in the market, an immense amount of realising will often be absorbed within three of four days or a week. But if speculation is narrow, prices may remain around top figures for weeks or months while big holdings are fed out. However wary the bulls may be in concealing their sales, their machinations will be discovered by watchful professionals and shrewd students. Once this 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. As a rule, buyers do not appear in force until a “bargain day” appears. Usually, a floor of stop-loss orders will hit, floor traders will seize the opportunity and put out short lines and a general collapse results. Here are plenty of stocks to be had cheap and different interests are picking them up.


Inverted Reasoning and its Consequences

It is hard for the average man to oppose what appears to be the general drift of public opinion.


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 horsepower 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. It will be observed that the above course of reasoning leads up to the conclusion that the most of those who talk about the market are more likely to be wrong than right. The daily 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.


The above was the most insightful part of this chapter. It goes on to talk about how, due to this reasoning, man becomes skeptical of the market, and that he can reason himself in circles. Basically, the outsider, the noob, if you will, takes bullish news as it comes, as bullish. The professional trader then reverses this and reasons that bullish news comes are a result of a vested interest wanting to sell, and so sells. An extremely skeptical or perhaps even more experienced trader may come to reverse this reasoning once again and assume that because most of the speculators are going against what “they” want you to believe, that he should in turn go against them. He therefore ends up in the same place as a market noob. The lesson here was to make use of common sense, and to use experience to know when to invert your reasoning and when not to.


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 stock”.


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.

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 the 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.

The lesson again is, you need enough experience to be able to rely on your own intuition. The inexperienced operator is left very much at sea. Bull news can be either (1) significant of a rising trend of prices or (2) indicates that “they” are trying to make a market to sell on. The inexperienced operator is playing with the professionals edged tools and is likely to cut himself.


If you are long or short of the market you are not an unprejudiced judge.

Try 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. 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.


“They”

If a man unfamiliar with stocks went to the various exchanges and listened to conversation of all sorts of traders and investors, the most pressing question in his mind at the end of it all would be, who are “they”?

If you asked 100 people, you’d get just as many answers. A. S. Hardy, professor of mathematics said that mat is a very poor mental discipline because it does not cultivate judgement. 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.

The market student of mathematical turn of mind is always seeking a rule or a set of rules, a “sure thing”. The stock market presents itself to George Selden as a purely practical preposition. 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.


The 3 main types of “them” 1. Floor traders 2. an association of powerful capitalists 3. Speculators and investors in general


The above 3 groups can all be working against each other at any 1 time aswell. 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.


Confusing the Present with the Future – Discounting

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. The average man is not blessed.. or cursed.. – however you want to look at it – with an analytical mind.

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 judgement.


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”


Some events cannot be foreseen, or discounted, i.e. an earthquake. But things other than acts of God go unforeseen. Supreme Court decisions etc. If the effect of an event does not make itself felt before the event takes place, it must come after. Any event that is under the control of capitalists will usually be pretty heavily discounted before it occurs.

The extent to which future business conditions are known to “insiders” is, however, usually overestimated. So much is out of the control of humans that the future of business becomes a very complicated problem.


The great question is; “when will the buying or selling become most general and urgent?”

Even the clearest mind and most accurate information can result only in a balancing of probabilities.


In some cases the uncertainty which precedes such an event is more depressing than the worse that can happen afterwards (Supreme Court decisions) Sometimes it’s the uncertainty that’s bearish, not necessarily either decision.


It is the overextended speculator who causes most of the fluctuations that look absurd to the sober observer. It does not take much to make a man buy when he is short of stocks “up to his neck.” A bit of news which he would regard as insignificant at any other time will then assume an exaggerated importance in his eyes. His fears increase in geometrical proportion to the size of his line of stocks.


Fluctuations based on absurdities are always relatively small. They are due to an exaggerated fear of what “the other fellow” may do.


Every situation is new, though usually composed of familiar elements. Each element must be weighed by itself and the probably 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?”


Confusing the Personal with the General

Talleyrand said that language was given us for the purpose of concealing thought. Likewise many seem to think that logic was given us for the purpose of backing up our desires.

In the market, we cannot work for our own interests as in other lines of business – We can only fit our interests to the facts.


To make the greatest success it is necessary for the trader to forget entirely his own position in the market, his profits or losses, the relation of present prices to the point where he bought or sold, and to fix his thoughts upon the position of the market. If the market is going down the trader must sell, no matter whether he has a profit or a loss, whether he bought a year ago or two minutes ago.


“Stop your losses; let your profits run” is a saying which appeals to the novice as the essence of wisdom. But the whole question is where to stop the losses and how far to let the profits run. In other words, what is the market going to do?


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

The same remakes would apply to the detection of accumulation or distribution. If you want to see distribution after a sharp advance, you are very likely to see it. If you have sold out and want to get a reaction on which to re-purchase, you will see plenty of indications of a reaction. Indeed; it is a sort of proverb in Wall Street that there is no sort so bearish as a sold-out bull who wants a chance to repurchase.


In the study of so-called “technical” conditions of the market, a situation often appears which permits a double construction. Indications of various kinds are almost evenly balanced; some things might be interpreted in two different ways; and a trader not already interested in the market would be likely to think it wise to stay out until he could see his way more clearly. Under such circumstances you will find it an almost invariable rule that the man who was long before this condition arose will interpret technical condition as bullish, while the man who was and remains short, sees plain indications of technical weakness. Somewhat amusing, but true.


It remains true that the very moment when the market looks strongest, is likely to be near the top, and just when prices appear to have started on a straight drop to the zero point is usually near the bottom. The practical way for the investor to use this principle is to be ready to sell at the moment when bull sentiment seems to be most widely distributed, and to buy when the public in general seem most discouraged.

Study the psychology of the crowd as it manifests itself in the movement of prices.


The Panic and the Boom

Both the panic and the boom are eminently psychological phenomena. The panic represents a decline greater than is warranted by conditions, usually because of an excited state of the public mind, accompanied by exhaustion of resources; while the term “boom” is used to mean an excessive and largely speculative advance.


Final low prices are the result of necessities, not opinions. Everyone may know perfectly well that stocks are selling below their value – the trouble is that investors can’t get hold of the money with which to buy. The moral is that low prices, after a prolonged bear period, are not in themselves a sufficient reason for buying stocks. The key to the situation lies in the accumulation of liquid capital.


The word ‘fear’ may be overused, as people don’t often sell from the emotion of fear. But a feeling of caution strong enough to induce sales or even a fixed belief that prices must decline constitutes in itself a sort of modification of fear and has the same result so far as prices are concerned.

This fear is even more important in preventing purchases, not sellers. It takes far less uneasiness to cause the intending investors to delay purchases than to precipitate actual sales by holders. The offerings may be small, but nobody wants to buy them.

It is this factor which accounts for the rapid recoveries which frequently follow panics. Waiting investors are afraid to step in front of a demoralized market, but once the turn appears, they fall over each other to buy.


Money fluctuates and changes value just like iron or potatoes. We are accustomed to figuring the money-value of wheat, but we get a headache when trying to reckon the wheat-value of money.

It is generally more difficult to distinguish the end of a stock market boom than to decide when a panic is definitely over.


The Impulsive versus the Phlegmatic Operator

*important – accumulation and distribution;

You have impulsive operators – “conditions, both fundamental and technical warrant higher prices. Stocks are a purchase” – he buys. He doesn’t expect to buy at the bottom. He is perfectly willing to buy the top if he sees it going higher.

Phlegmatic operators – big capital interests – they Dollar Cost Average. they buy or sell on a scale.


These 2 types of operators are always working against each other.

The buying and selling of the impulsive trader tends to force prices up or down, while the scaling in of the phlegmatic class tends to oppose any movement. Imagine banking interests believe conditions to be fundamentally sound and that the general trend of the market will be upward for some time to come. Orders are placed by various persons to buy stocks every point down, or every half etc. On the other hand, the active floor traders find that, owing to some temporary unfavorable development, a follow can be obtained on the bear side. They perceive the presence of scale orders, but they think stocks enough will come out on the decline to fill the scale orders and leave a balance over. in other words, bears will win. To put it another way, the floating supply of stocks has become, at that moment, larger than can comfortably be tossed about from hand to hand by the in-and-out class of traders. These conditions produce what is commonly called a “reaction”. Once the surplus floating supply of stocks is absorbed by standing orders, the market is ready to start upward again. If the general trend is upward, far less resistance will be encountered on the advance than was met on the reaction; hence prices rise to a new high level. Then profit-taking sales will be met on limited or scale orders at various prices, and as the market advances the floating supply will gradually increase until it again becomes unwieldy and another reaction is necessary. Eventually a level is reached, or some change in condition appears, which causes these scale buying orders to be partially or entirely withdrawn, and selling orders to be substituted on a scale up. The bull market will not go much further after this change takes place. It has now become easier to produce declines than advances. The situation is the reverse of that described above, and a bear market follows.

Commonly there is a considerable period around top prices when scale buying orders are still found on declines, but profit-taking sales are also met on advances, so that the market is kept fluctuating within comparatively narrow limits for a month or more. In fact, it is likely to be kept on this level so long as public buying continues greater tha public selling. This is sometimes called “distribution.”


A similar period of “accumulation” often occurs after a bear market has run its course, and before any important advance appears.


Toward the end of the bull market a change is noticeable. Prices go down easily and on larger transactions, while advances are sluggish and opposition is met at higher levels where profit-taking orders have been placed. In a bear market, pressure appears in place of “support”. The end of the bear market is marked by the reappearance of “support” and the removal of “pressure” so that prices rebound quickly and sharply from declines.


The book finishes with 5 main tips;


(1) Your main purpose must be to keep the mind clear and well balanced. Hence, 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.

(2) Act on your own judgment, or else act absolutely and entirely on the judgement of another, regardless of your own opinion. “Too many cooks spoil the broth.”

(3) When in doubt, keep out of the market. Delays cost less than losses.

(4) Endeavor to catch the trend of sentiment. Even if this should be temporarily against fundamental conditions, it is nevertheless unprofitable to oppose it.

(5) 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.

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