The Astute Speculator
Moneymaking Stock
Market
Trading Advice
From the Masters
By Eric L.
Prentis
Copyright © 2012 Eric L. Prentis
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The intended purpose of The Astute Speculator is to present faithful and useful information on stock market investing. Stock market buy, sell, or hold recommendations are not made in this book and should not be assumed. Professional services—such as legal, accounting, tax, insurance, or registered investment advice, etc.—are not offered in this text. If you desire professional services, please contact legally licensed professionals directly.
This book is also available in print at online booksellers.
Table of Contents
Introduction
Speculative
Experience
Speculative Overview
What Is An Astute
Speculator?
Be An Expert Investor First
Speculative
Questions
Speculative Questions Answered
Purchase This
Book
Website Commands
Bibliography & Glossary
Chapter
1: Principles Of Speculation
Speculation
Defined
Business And Stock Market Speculation
Markets Are
Essential
Stock Market Speculation
Amateur Speculators
Stock
Market Taxonomy
Speculative Theory
Speculative
Principles
Computer Graphs
Chapter
2: Short Selling
Most Speculators Trade Long,
Not Short
Optimists Vs. Pessimists
Short-Sale Traders
Technical
Rallies
Short-Sale Mechanics
Buy Ins And Short Squeezes
Float,
Short-Interest-to-Float And Short-Interest Ratio
Short
Selling
Professional Short Sellers
Short-Sale Trigger
Points
Financial Statements
Short-Sale Example: General Motors
Corp.
Chapter
3: Buying Common Stock
Buying Principles
Buying
At A Market Top
Planning And Scheduling The Stock Purchase
Time
To Purchase Stock
Technical Position
Rules When Purchasing
Common Stock
Purchase Price, Bids & Offers And Intrinsic
Value
Buying Trigger Points
Chapter
4: Selling Or Covering Stock
Selling Or
Covering Principles
Psychology Of Selling Or Covering Stock
Real
Profits Vs. Paper Profits
Second Art Of Speculation
Stop-Loss
Orders
Calculating Stop-Loss Orders
Stop-Loss Orders In
Practice
Chapter
5: Volume And Turning Points
Tape Reading
Basics
Tape Reading Analysis
Trading Volume
Activity
Intermediate-Term Trading Volume Activity
Turning
Points
Supply And Demand At Turning Points
Turning Points:
Speculative Issues
Chapter
6: Momentum Speculating
Sectors
Sector
List
Industry Groups
Outstanding Industries By Decade
Industry
Momentum
Momentum Investing
Momentum Speculating
Chapter
7: Money Or Risk Management
Money Or Risk
Management Rules
I. Save Half The Profits
II. Learn To “Say
No” And Keep A Cash Reserve
III. Protect Risk Capital
IV.
Focus Speculating
V. Stay With The Winners
Program
Trading
Program Trading Strategies
Chapter
8: Speculative Bylaws
Use An Appropriate
Method
Speculative Priorities And Techniques
Character And
Personality Traits
Speculative Bylaws
The Best
Speculators
Simulator Or Paper Trading
Trading With Money
Chapter
9: Speculative Strategies
Select An Appropriate
Strategy
Strategy A: Panic Or Contrarian Specialist
Panic Or
Contrarian Specialist Example: Intel Corp.
Strategy B: Box
Theory
Box Theory Example: Google Inc.
Strategy C: Tandem
Trading
Tandem Trading Pivot Points
Chapter
10: Futures And Options
Futures Market
Hedge
Funds
Price Spread Strategies
Options Market
Options Price
Determination
Options Strategies
Options On Futures
Futures,
Options And Options On Futures Problems
Conclusion
Practical
Benefits
Speculative Arts And Scientific Factors
Speculative
Conclusions
Eight Astute Speculator Firsts
Continued
Communication
About The Author
Earning +33 percent per year speculating in the stock market, in both good times and bad, and retaining the profits once earned are challenging but realistic goals and the focus of this book. Trying to beat the stock market with what is learned in other professions and a smattering of Wall Street lore is almost certain to fail, as approximately 95 percent of beginning speculators discover.
Few gain correct speculative awareness before trading. Novice traders use trial and error, and experience becomes the initial teacher. Speculating in the stock market without the necessary understanding and practice is often a harsh, confusing and expensive introduction.
Learn eleven key scientific speculative factors, three speculative arts and ten speculative bylaws necessary for correct stock market speculation. Success when speculating is best achieved by first becoming a knowledgeable stock trader, then practicing using simulator trading, next performing odd-lot trading with limited funds and only then graduating to trading in round lots.
The essential trading wisdom and moneymaking advice from forty-five classic books and articles from the masters on stock market speculating, ensures that you learn from the best in a short period.
Speculative Experience
Most speculators find out about the stock market the hard way, simply by doing. Learning by doing, common when starting out in other businesses, is an expensive way to acquire the skills of a successful stock market speculator. By reading this book and applying its lessons well, novice speculators avoid many ruinous pitfalls that await those who begin speculating without first learning how.
Experience by itself does not inform on the lessons learned. Events merely appear without a frame of reference. Unaware speculators, during a stressful trading experience, do not recognize the important trading signs appearing right before their eyes, even though they think they see what is happening. Important data and information significance hides among the thousands of distracting facts and opinions.
Some will say, “Yes but, experience is the best teacher and he or she will do much better next time.” Nevertheless, if the bad experience traumatizes the losing novice speculator so they never want to see or hear about the stock market again, this cancels a good learning experience.
Learn First, Before Doing
The man or woman who masters the knowledge of stock market speculation, as presented in this book, is exceptional because few accomplish this task before they begin trading. Speculators should take a pledge to shun Wall Street until knowing they are doing the “right thing” and the “thing right.” Before speculating in the stock market, first learn about one of the most all-encompassing, strategic, fast paced and complex professions in the world.
Perhaps in no other professional activity will correct understanding pay higher dividends than learning beforehand how to trade properly in the stock market. Correct speculative theories, strategies and methods presented in this book succinctly explain how to make money in the stock market.
A positive approach in this book explains stock market speculation. The goal is to point speculators to essential speculating knowledge and to what that knowledge means. The stock market is a mental game— next.
Mental Game
Stock market buying and selling is a mental game based upon the perceptions of participating traders. Taking advantage of market inefficiencies and winning on Wall Street is the province of those with the correct knowledge, foresight, patience, humility, iron nerve, discipline, judgment and having the courage to take proper action.
Albert Einstein (1879-1955) says, “The definition of insanity is doing the same thing over and over again and expecting a different result.” Do not be delusional. Failure in the stock market, as in business, is thinking in an intellectual rut. Only after losing most or all their money do speculators finally realize they have to think differently to be a success when trading common stock. Therefore, losing speculators should change their beliefs, desires, decisions and actions to achieve speculative success.
Beginning speculators should develop a reference for both understanding and feeling comfortable trading common stock. The Astute Speculator helps speculators feel confident in taking control of their money when speculating.
Speculative Overview
Stock market speculation is both an art and a science. The study of eleven key scientific speculative factors include what stage the market is in, the market’s trend, whether the market is undervalued or overvalued and how to calculate a corporation’s margin-of-safety multiple. The three speculative arts are: 1) how to time stock buying or short selling over the intermediate- term using turning points and trigger points; 2) how to sell or cover a stock position by taking the emotion out when using stop-loss orders and money management rules; and 3) knowing yourself and what approach will work best for you based on your character, personality and lifestyle.
Successful speculators master the art of short selling, which is not “un-American.” Making a purchase commitment on a stock is difficult but less emotional than concluding it. Learn how best to accomplish both. Recognize that sectors and industries have a major influence on how a stock within that industry behaves, over the intermediate term.
Price action indicates but is secondary in importance to trading volume, which validates the stock market’s buy-side advance or sell-side decline. Learn how to use tape reading to recognize trigger points to capitalize on market turning points. Use the speculative bylaws and money management rules to become a successful speculator. Speculative strategies have to fit the speculator’s character, personality and lifestyle to be effective—learn how to accomplish this.
Stock market speculating is a first-class profession. You require no outside office, no employees nor clients. Connect your computer to the Internet and live anywhere in the world. Many want to enter this unsurpassed speculative profession but few take the time to properly learn and practice before beginning, and predictably, they fail.
Speculative Goals
Challenging but reasonable goals when speculating are to earn three times the average super long-term S&P 500 Index return of approximately +11 percent per year, i.e., +33 percent per year. Then, retain profits, which is the real endgame. The most significant goal in stock market speculation is to have money available at the end of your trading career for a new life interest, leisure, or for a comfortable retirement.
Do Not Force The Stock Market
Do not try to force the stock market to fit your needs. Those who want the stock market to pay their weekly bills by trying to scalp full-or-half point moves in a stock will fail. Trying to make the stock market pay for an expense or a particular bill is futile. Unfailingly, the timing is wrong resulting in impulsive or unreasoning trades.
Astute speculators should take what the market gives them on the market’s terms. Think of determining the objective truths of “what, when, who and where” of stock speculation as detective work and going on a journey of discovery.
How To Succeed On Wall Street
There is a saying on Wall Street, “Persons who act like stock market speculation is the road to riches, frequently go broke; however, persons only wanting a reasonable profit on their money, have the best chance of becoming rich.”
Speculators learn that correct trading is not a random activity, nor mere chance or luck; but a rigorous undertaking that requires eliminating risk as much as possible before taking a stock position. Accomplish this by relying on a suitable approach to the speculator, calculation, analysis, evaluation, good judgment and the courage to act properly.
Know the proper trading principles and follow the ten speculative bylaws for speculative success. Know yourself, do not overreach, and practice first using simulator trading. Start trading initially using odd-lot trades with limited funds and only then graduate to regular round-lot trading. Do not take unduly large risks in the stock market.
The purpose of this book is to point readers toward essential speculating knowledge and to what that knowledge means, transforming novice speculators into astute speculators—as described next.
What Is An Astute Speculator?
An astute speculator has foresight, a cool temperament, a clear mind, patience, iron nerve, discipline, is shrewd, and humble. She or he is keenly aware of what information and data are the most significant in stock market speculation, with the courage to act on that information.
Astute speculators plan and know where to find data necessary to perform calculations and how to interpret these results for proper decision-making. Astute speculators are seekers of truth, possess market vision, speculative intelligence and can take appropriate action based on practical stock market experience.
How To Become An Astute Speculator
The best stock market speculators are continuously learning how to trade. Speculators should ask themselves if market or stock price movements excite them. If speculators cannot wait to understand why price movements are occurring, these persons should delight in speculating.
To become a speculative professional and make a living from the stock market, it is imperative that traders take their calling seriously. Success in the stock market entails earnest, exhaustive study and only then taking proper action.
Trading stock looks deceptively easy to the uninformed. However, speculation can be especially trying. The axiom is, “One gets out of life an equal measure put into it.” Since the goal is to make outsized profits in the stock market by having money work extra hard, this requires speculators to work especially hard because no one earns something for nothing in life.
How speculators implement the information presented and the effort put forth when speculating ultimately establishes how successful they become when trading. Knowing what is in this book and applying it correctly, compared to others, makes these knowledgeable individuals speculative winners. To be an expert stock market speculator requires first being an expert investor, as described next.
Be An Expert Investor First
First, become an expert investor before attempting stock market speculation. An outstanding investor knows whether the overall stock market is undervalued or overvalued, if the market is in a long-term upward trend or long-term downward trend, what the most promising stock to buy is and what interest rates to monitor.
Astute investors use investment models, know where to find data on the Internet to perform calculations, understand what the results signify, can properly take action and are familiar with the following concepts.
1. Understands the difference between systemic risk and unsystemic risk.
2. Knows how the stock market acts as a discounting mechanism.
3. Fully understands diversification versus concentration of a stock portfolio.
4. Knows whether the overall stock market is either undervalued or overvalued.
5. Knows how the rational, non-rational and irrational behavior of stock traders affect their actions.
6. Can determine the four stock market stages and how that affects speculating strategy.
7. Understands corporate intrinsic value, market value capitalization, bargain values and how to use margin-of-safety multiples to evaluate common stock.
8. Knows the political-economic conditions and how they affect the stock market.
9. Can determine interest rate spreads and how yield curves affect the stock market.
10. Understands the use of expected and unexpected news in the stock market.
11. Knows and can apply the contrarian method.
12. Can implement the practical ten-step method for investment success.
After feeling comfortable deciding and performing properly on diversified portfolios over the long term of 1, 2, 3, 4, 5 years or more, novice speculators may make judgments and perform successfully on concentrated portfolios over the intermediate term of 1, 2, 3, 4, 5 months or more. For those new to stock trading or for those who would like an investment refresher course, please use The Astute Investor, Prentis (2012)—see the bibliography for the specific reference.
Stock Market Stages
Correctly identifying with 95 percent certainty which of four stages the stock market is in is fundamental to good speculating. Understand the following four stock market stages referenced throughout this book:
Stage 1: Mark-Down – Downtrend
Stage 2: Accumulation –
Bottoming
Stage 3: Mark-Up – Uptrend
Stage 4: Distribution –
Topping or Rounding Over
Use the S&P 500 Index Nine Month Moving Average Trend Line with confirming indicators, as discussed in chapter 4 of The Astute Investor, to help determine the four stock market stages.
Do Not Rely On Luck
Speculators learn that correct speculating is not mere chance or luck but an activity relying on proper policy, analysis, foresight, patience, character, discipline, good judgment and timely action. Astute speculators have the advantage when competing against persons who do rely on luck.
Study the practical day-to-day solutions to the problems of speculating and Internet websites on where to find the appropriate data for speculators to calculate models for themselves. Ask the following fundamental speculative questions that are important to stock market traders.
Speculative Questions
Stressing only the answers to stock market speculation is unwise. Speculators repeatedly find it more instructive to learn the correct questions they should ask rather than a momentary correct answer, such as in a monthly market newsletter. Correct answers are for a specific time and place. Correct questions and solution methodologies transcend both and are universal.
The Astute Speculator helps speculators answer, for themselves, the following fundamental speculative questions:
1) What speculative principles are important?
2) Why is being a good short seller important? What are trigger points?
3) Why is the buy decision complex and timing critical?
4) Why is the sell or covering decision emotional, and how to complete trades successfully?
5) What aspects of trading volume are important when identifying turning points?
6) How can sectors and industries help recognize intermediate- term speculative momentum?
7) What character traits do winning speculators have and what are the ten speculative bylaws for trading success?
8) What money management rules reduce risk and ensure a profitable retirement?
9) Each speculator’s character, personality and lifestyle have to match their speculative strategy, why?
10) What are the strengths and weaknesses of participating in the futures and options markets?
Each of the chapter topics in The Astute Speculator support speculators by helping him or her answer these fundamental speculative questions for themselves, next.
Speculative Questions Answered
The following chapter synopses highlight the solution methodologies presented to allow speculators to answer these ten speculative questions.
1) Speculative principles cover both the art and a science of speculation. Use the eleven key scientific speculative factors and the three speculative arts and techniques for solution. Theory calls the stock market the “unbeatable game,” learn how to beat it. The stock market taxonomy categorizes the stock market for better communication and understanding.
2) Most speculators trade on the long side of the market. Astute speculators trade on the short side of the market, as well. Learn how to sell stock short using trigger points.
3) The ability to “say no” to a stock purchase is key. Learn whether to buy now or later, what stock to buy and at what price. Patience is necessary when making the buy or short sale decision, learn why. Making a purchase commitment is difficult but less emotional than concluding it. Learn why keeping a cash reserve is imperative.
4) Learn how best to sell or cover stock. Selling stock, both for amateurs and professionals, is emotionally difficult. The stop- loss order is certain protection against a speculator’s human weakness when it comes time to sell or cover. Understand the effect use of stop-loss orders.
5) Price action indicates, whereas trading volume validates. Learn how to read the tape. Identify trend changes by using price and volume transactions that show up on the tape. Turning points indicate a stock market losing intermediate-term momentum, either up or down. First, recognize the turning point and then speculate on the correct side of the market.
6) Momentum speculating is different from momentum investing. Sectors and industries typically either lead, lag or are coincident with the overall stock market’s long-term trend. Consequently, determine the intermediate-term momentum of a stock. Industries high and low rankings help specify the leading stock within that industry for purchase or the lagging stock to sell short.
7) Learn the character traits of the best speculators. Astute speculators should follow the speculative bylaws when trading. Use simulator trading is a good first step when practicing. Start with limited funds to reduce emotional stress when trading with money, only when successful, graduate to trading in round lots.
8) Money management issues force speculators to prepare for possible trading losses. Money management rules focus on position size or determining how many shares to acquire, to the total amount of risk capital available to the speculator. Money management is about determining the risk of the trade based upon the percentage of the total risk capital put into each trade. Understand focus speculating, drawdown, emotional trading zone and calculating the reward-to-risk ratio.
9) How each speculator responds to the pressures of trading in a volatile stock market is unique. Therefore, each speculator must devise a speculative plan that works best for their character, personality and lifestyle. The three strategies presented are: 1) panic or contrarian specialist; 2) box theory; and 3) tandem trading. Select one of these strategies to implement, or combine different aspects for an approach that works best for you.
10) Study futures and options exchanges. Use different call and put strategies. Learn the good options strategies with the possibility for unlimited gain and limited loss. Understand why the futures and options markets are problematic for astute speculators.
Purchase This Book
Purchase this book because:
1) Speculators who need to understand a seemingly confusing and mysterious stock market. In addition, those who desire gaining essential trading knowledge grounded in the science of speculation.
2) Those who desire a systematic approach to stock market speculation that includes becoming an expert investor first. Speculators learn important website addresses and how to find current data on the Internet to do the necessary model calculations for themselves.
3) Speculators who demand more than just description and theory; but, also how best to gain practical experience.
4) Financial services professionals who need to fully comprehend and explain the stock market to their clients.
Knowing exactly what the stock market will do is impossible. However, speculators have probabilities in their favor by purchasing, reading and correctly implementing the presented material in The Astute Speculator.
Website Commands
Current market data are necessary for speculators to run speculative models for themselves. Therefore, identifying websites with defined commands necessary to find specific current data and information are in bold letters. First, find the website logon address. Inside the brackets is where to look on the computer screen, what to click on or what information to type. An example follows:
Logon: http://finance.lycos.com
Where: [Where to look on the computer screen (e.g., on the top heading, along the left column, or in the main body) and the name of what to look for]
Click: [What specifically to click on the computer screen to find the next screen or the necessary data]
Type: [Necessary to type in information] Many steps may be necessary, requiring various Where, Click and Type instructions.
Bibliography & Glossary
The Astute Speculator incorporates the essential speculative wisdom and moneymaking advice from forty-five classic books and articles from the masters on stock market speculating, presented in the bibliography section. Individuals study from the best and save considerable time learning how to trade. The glossary contains a financial dictionary of speculative words. Chapter 1 discusses speculative principles, next.
Chapter 1: Principles Of Speculation
Introduction
Speculation defined. The similarity of stock market speculation to business speculation is presented. Stock market speculation over the intermediate term is both an art and a science. Learn the eleven key scientific speculative factors and the three speculative arts determining success.
Understand why the stock market is inefficient, and therefore necessary. Recognize the importance of markets and exchange to the economy’s welfare. Appreciate why stock market speculation is a socially necessary profession responsible for directing funds to high value opportunities, i.e., the leading companies in the highest-ranking industries.
Study stock market speculative theories and principles. The stock market is called “the unbeatable game.” Ironically, the stock market does not beat speculators, instead, learn why it is the speculators’ unique unreasoning instincts that cause their own failure. Learn how speculators should counteract their natural but incorrect trading tendencies.
Speculation Defined
Speculate, from Webster’s dictionary, comes from the Latin word “speculari,” which means, “to spy out, look out, observe and examine.” A speculator is a risk taker who contemplates the past, present and the future. Understands theoretically, what objective and subjective truths portend—using premises without benefit of scientific experimentation. Has vision into the future and acts to position himself or herself properly before an uncertain but expected result happens.
Speculation first occurs on a philosophical or perceptual level and then progresses to a practical or commercial reality. Speculators take responsibility for their actions and strive to be in the “knower group” rather than be in a sheepish crowd of simple “believers” who follow others’ opinions.
The following are essential for speculative success, speculators must:
1) know and properly analyze objective and subjective truths affecting the nature of the endeavor and its expected outcome; 2) interpret correctly what this analysis means and arrive at a prudent judgment; and 3) take proper action to successfully apply and accomplish practical or commercial endeavors—balancing patience with swift action is often necessary during step 3.
Business And Stock Market Speculation
The American dream of achieving a better life through hard work, daring and resolve is alive and well in the United States (U.S.). Consequently, Americans, by their temperament, are risk takers and naturally love to speculate. There is nothing unique about speculation; it takes place in many fields of business that are new to the individual just beginning an enterprise.
Identify a speculative opportunity in agriculture, mining, manufacturing, retailing, the arts, or the stock market. Systematically analyze and determine if the new product, process, marketing and financial conditions are beneficial and lucrative for the speculator. Because the business endeavor is new, it may seem hazardous. But, the expectation is the new product or service is indispensible and has the probability of profit when presented for sale in the marketplace.
Americans speculate regardless of the risks, as a result, using laws and legislation to protect speculators from attempting seemingly unwise endeavors is impossible. Since the way is open for all Americans to speculate, it behooves all speculators to acquire as much knowledge before attempting the speculative task to secure the best chance for success.
The probability for business success increases exponentially by the understanding speculators have before commencement of the speculative act. Stock market speculation is but a subset of business speculation and perhaps requires the most specialized knowledge for persons to be successful, next.
How Business And Stock Market Speculation Are Alike
The underlying rule for success in the stock market is no different from any commercial enterprise. One’s speculative profits depend, like any store merchant, on the ability to sell purchased goods at a higher price than acquired. Therefore, think of common stock as a speculator’s merchandise.
This principle applies to real estate, retailing and all lines of business, not just on Wall Street, and the objective is simple—“buy low, sell high.” Consequently, it is best to buy common stock with sound fundamentals going up in price and therefore ensuring a profit. Promotion is important in business as well as the stock market, next.
Business And Stock Promotion
Businesses get customers to purchase goods and services at higher prices by advertising and promoting the benefits of these products and services. Discussing product or service flaws occurs, but only with positive spin to present any drawbacks in the best possible light.
The stock market uses promotion. On Wall Street, the most effective promotion takes place in the news media. Therefore, speculators take advantage of this fact by using correct buying and selling trigger points based on the daily news, discussed in chapter 2.
Markets Are Essential
Economic society develops markets, typically where people congregate in towns and cities, to aid distribution through exchange. Markets, at a specific location or under the auspices of an institution, determine where buyers and sellers may come together to transact business. Markets bring order out of disjointed haphazard exchange operations. Speculative exchange differences make markets necessary.
Exchange is the engine of social progress. Exchange takes place between people and the natural physical world, as well as solely between people. Production of products or services and distribution at exchange markets are symbiotic. Production cannot exist without distribution at exchange markets and distribution at exchange markets cannot exist without production. Cooperation through exchange between people and nations is a major force unifying the world.
Speculators are necessary for the proper functioning of exchange markets. Business speculators attempt to equalize the exchange of the business supply and demand. And by so doing, the resulting price range is smaller and fluctuations are less abrupt than they would be without speculative activity. The stock market is but a subset of exchange markets and is never in equilibrium for long, as explained next.
Stock Market Disequilibrium
A stock market always in equilibrium and therefore efficient is unattainable. Grossman and Stiglitz explain that it is impossible for the stock market to always be in equilibrium and therefore efficient because traders have different endowments, beliefs and preferences. Therefore, the stock market is not in equilibrium for long, nor is it efficient.
Human progress constantly throws the economic supply and demand equation out of balance that then becomes the speculator’s challenge. The inefficiency of the stock market not in equilibrium is good for astute speculators, because, outsized returns on stock positions are possible.
Exchange markets always in equilibrium and efficient are not necessary. A government agency would set quality, quantity, and delivery and price conditions for every commodity, product and service needing distribution. Even during wartime, markets are necessary, i.e., government price control agencies do not work well for long— presented next.
Why Markets Are Necessary: An Example
John Kenneth Galbraith (1908-2006) is the “price czar” administrator of wage and price controls at the Office of Price Administration during World War II. Price controls grew more and more controversial as industry representatives began complaining long and loud about Galbraith’s price setting during the Second World War.
The process of setting wages and prices by government fiat became increasingly dysfunctional and, consequently, Galbraith resigns under pressure in 1943. Galbraith says of his experience, “I reached the point that all price fixers reach, my enemies outnumbered my friends.” Markets are impersonal and ensure that managers respond rapidly to unbalanced conditions where the resulting new prices communicate necessary future production, distribution and exchange operations.
Stock Market Speculation
The speculator’s challenge in the market is that human progress constantly throws the economic supply and demand equation out of balance. Intelligent stock speculation is both an art and a science and is not frivolous gambling but a reasoned endeavor to foresee and profit from an economic future state of affairs.
The stock market is only a barometer that registers what political- economic conditions are likely to be. A security market does not cause what happens in business, in government, or world affairs, but is merely a financial record of coming events.
Speculators should always be looking forward to visualize what would happen three-to-six months into the future and not fixate on past or present events. This separates speculators from business managers and those in government who, because they focus upon current conditions, are often unseeing and caught unaware by sudden changes.
Stock Market Musical Chairs
Participating in the stock market is a little like playing a child’s game, musical chairs. While the music plays, the chairs are empty and plentiful, the game is easy and enjoyable.
Similarly, when the good financial and economic news is in the media, speculators walk around with “stock not for sale signs”—stock bids at higher and higher prices seem plentiful. However, let the pleasing financial and economic good news stop, speculators all rush to sell and the high-priced stock bids vanish, except at drastically reduced prices.
This is the importance of anticipating the end of the wonderful financial and economic good news, before its ending. Looked at another way, it is also important to begin speculating by purchasing stock before the good- news starts. Knowing “when” to buy or sell stock, based on promotional financial and economic news, is the speculative key.
Stock Market Speculation Requires Foresight
Stock market speculation is a venturesome, risky and deliberate choice made with the belief that you can earn an extraordinary profit. Speculation requires foresight into coming expected events, correct observation, the intellectual exertion of planning and scheduling, knowledge of political-economic conditions, arriving at proper conclusions and then taking timely action.
The investing public does not foresee stock market coming events, but concentrates instead on past stock prices and current financial and economic news. Present conditions are the only benchmark. Consequently, daily financial and economic news does not move the stock market as expected by the investing public. This process characteristically promotes stock market movements, encouraged by the daily news, leading to crowd or herd behavior.
When greed or fear dominates and unaware speculators, who look upon the stock market as little more than a gambling casino, begin to trade impulsively—losses almost assuredly follow. Comprehension of correct stock market speculation reduces emotional stock trading risk to a minimum.
What Defines A Good Stock Market Speculator?
The stock market requires research to delve into the facts that eventually determine stock price movements. Speculation is not merely blind luck, which is the province of gambling, but making expenditures on enterprising positions with minimum risk.
The “when” of buying or selling short is more significant in determining speculative profits than the “what” to buy or sell short or the price, i.e., the “how much” of the transaction. Timing of the purchase or short sale is the primary speculative art, or the “art of arts.” Speculative profits in the stock market are first the result of precise timing when buying or short selling, second, the result of what to buy or sell short and only third, the transaction price.
Patience when speculating in the stock market is essential for success. It is worthy of note that a correct estimation by a speculator on a common stock is easier to achieve on Wall Street than having patience when speculating. Allowing a beneficial major stock price move to play out requires infinite patience and staying power.
Speculative Outcomes Vs. Expectations
Worldly wealth increases at a slow measured pace. Speculators assume that their speculative stock positions will increase in value at a higher compound growth rate. Consequently, the growth of worldly wealth does not match speculative expectations. Therefore, speculators should be proactive to be successful in earning above average returns at reduced risk in the stock market.
Absolute safety and surety in life as well as in the stock market are imaginary—they do not exist. The New York Stock Exchange Euronext (NYSE) [Deutsche Boerse merges with the NYSE in February 2011, the new company is yet unnamed], National Association of Securities Dealers Automated Quotation (NASDAQ) and NYSE Amex Equities make available regulated, impersonal settings for stock trading.
If speculative outcomes do not match expectations, it is necessary to change one’s approach to the stock market. Thinking in the same inferior rut produces speculative losses. Consequently, to change results for the better, speculators should improve their thinking based on correct stock market knowledge. Amateur speculators often have misplaced beliefs, as discussed next.
Amateur Speculators
Tyro speculators look at the whirling stock market and begin to concoct fantasies of great wealth. The novice speculator quickly makes a bet on a market pundit recommended stock on the nightly news, by an investment strategist reporting in a newspaper or newsletter, based on a “hot tip” from a friend. Alternatively, they purchase using price-to-earnings ratios they think indicates a company’s good value. The new speculator then says, “Even when the stock price declines initially, I hold on until the stock makes money.” This tyro investment scheme ultimately leads to disaster for as many as 95 percent of new speculators.
Eventually the stock price declines below the purchase price and our fearless—only because he or she does not know any better—rookie speculator holds on for a while, but eventually sells out near a market bottom in a fit of panic selling. At that point, the speculator loses all the profits and maybe most of the principal. The now fearful speculator feels the stock market is overly risky, mysterious and does not trust it. Many sold out novice speculators, after this sad experience; vow never to return to the risky stock market.
The royal road to success is not possible in other forms of business and is not possible on Wall Street, either. The initial monetary stake when speculating need not be large, what is important, however, is that speculators begin trading with the correct stock market knowledge.
Market’s Siren Song
The siren song to new stock market speculators is to make a vast amount of money in a short time, all while risking little capital and without having to work hard. Amateur speculators desire bragging rights for an easy road to financial riches. When their haphazard dabbling in stock speculation instead loses money, they wonder why
New speculators, without a basis for understanding the stock market, typically start with an advancing overall stock market and find it easy to make money, on paper. It becomes exciting to make money by speculating and novice speculators begin to believe that they have the whole speculating problem solved and wonder why no one else has recognized the obvious solution. But this naïve winning condition does not last for long.
Amateur speculators are susceptible to trading with money needed for living expenses and, consequently, do not have a clear mind. Do not attempt speculating with money required for pressing needs, such as, for the doctor, paying credit cards or the mortgage. Many amateur speculators trade who cannot afford to lose, consequently, they become frightened at the first perceived sign of trouble and begin to trade impulsively, which unvaryingly leads to disaster.
Common stock held by the investing public and amateur speculators are in “weak hands” because they trade on impulse. Easily frightened weak handed crowds often take the wrong action at the wrong time. Because crowds scarcely think, but instead, react impulsively. Amateur speculators often look at speculation as just gambling, which it is not, as presented next.
Stock Market Speculation Is Not Gambling
Stock market speculation, when performed properly, is not gambling. With gambling, contrived and needless risks are for escape, entertainment or for the most likely reason, the need for action. The possibility is for financial gain with immediate gratification, typically with poor odds for the player and advantageous odds for the house or casino.
Stock market speculation, on the other hand, is a socially necessary endeavor. Production, distribution and exchange risks are already present in the economy, the only question for a businessperson is, “who shall assume these risks?” Speculators bear risks that businesspersons wish to pass along to others. Unlike gambling, both sides of a stock market trade may profit from the exchange, over time.
Stock market speculators take risks because their judgment convinces them they will profit by their achievements. The stock market tests speculators’ knowledge, experience, character and courage by their action collecting capital for industrial use, thus making the economy more secure and prosperous.
Efficient Market Hypothesis
The efficient market hypothesis (EMH) and random walk theory of stock prices assumes that speculating in the stock market is like betting on American roulette in a gambling hall. This is scientifically incorrect (please see Prentis, 2011). Unfortunately, many speculators falsely believe that stock market speculation is casino gambling.
Gambling in the stock market is the wrong way for amateur speculators to operate. Rather than fear losing a small run-up in a stock’s price, hope a small profit would eventually become a large profit. Rather than hoping the stock, once down in price will return to its purchase price, one must fear that a current small stock loss will develop into a major loss.
Amateur speculators have ideas turned upside down, i.e., they hope when they should fear and fear when they should hope. Learn to fear that a small loss will turn into a large loss, instead of being a risk taker during a stock price decline. Learn to hope that a small profit will turn into a large profit, rather than being risk averse during a stock price advance.
The correct policy is: 1) keep the stock position for a large gain only when winning; and 2) when losing, only lose a small amount. The taxonomy to categorize and help understand the overall stock market is next.
Stock Market Taxonomy
The Astute Investor first presents the stock market taxonomy and covers the subject material in categories 1, 3 and 4. That is, how to use an asset allocation, dollar-cost averaging, buy-and-hold strategy to invest over the super-long-term of 20 years or more, and in the S&P 500 Index and common stock of individual companies over the long-term of 1, 2, 3, 4, 5 years or more.
Table 1 – 1: Stock Market Taxonomy category 6, the shaded area, is the subject category addressed in this book where speculative decisions on common stock of individual companies over the intermediate-term of 1, 2, 3, 4, 5 months or more is the focus.
The X-axis depicts the S&P 500 Index and individual common stock. Speculating in the S&P 500 Index versus an individual common stock is different due to the differences in their systemic and unsystemic risks. The Y-axis is the time dimension on Table 1 – 1, covering super- long-term, long-term, intermediate-term and short-term planning horizons.
Graphs & Charts
Graphs and charts present a historical picture and are a good way to visualize what is occurring on the stock tape. Use the perspective of monthly charts for long-term decision making concerning the S&P 500 Index.
Weekly charts include more historical data on one chart at a single glance than daily price charts. Consequently, use the perspective of a weekly chart for intermediate-term decisions on common stock of individual companies.
Use weekly Japanese candlestick price charts with trading volume bar charts to get a good picture of common stock intermediate-term pattern recognition. Watch for double top or bottom or head and shoulders top or bottom reversal patterns. In addition, higher highs, higher lows, and lower highs, lower lows are easier to identify on weekly charts.
Support and Resistance
Support is that point on the graph or chart where the price decline holds as buyers emerge on the downward price reaction. Resistance is that point on the graph where the price advance stops as traders begin selling on the upward price bulge. Chapter 5 discusses support and resistance levels, which represent potential supply and demand for stock.
Resistance becomes support, if instead of sellers appearing, the price significantly, by more than one percent, breaks above the previous resistance level. Thus, in a long-term and intermediate-term upward sloping market, higher highs and higher lows are in evidence.
Support becomes resistance, if instead of buyers, the price significantly, by more than one percent, breaks below the previous support level. Thus, in a long-term and intermediate-term downward sloping market, lower highs and lower lows are in evidence.
Support and resistance levels revealed on weekly charts, and then on daily charts to confirm specific price levels, are important when setting stop-loss order price points. Use intraday prices rather than closing prices when setting stop-loss order points, as explained in chapter 4.
Speculative Theory
Stock market speculation is an effort to reduce risk through knowledge and then to balance being suitably adventurous without overreaching. Unfortunately, human nature errs on the side of making fools of ourselves in groups and being too timid when on our own. To fight timidity, gain the knowledge necessary to proceed with courage when acting alone. Resign yourself to be humble in the face of the stock market, but do not accept defeat.
Do not think of the stock market as a frivolous game that is dependent upon luck, but a serious endeavor that through the speculator’s efforts help determine the well-being of a public company, an industry and the overall economy. The duty is upon the speculator to select the most promising stock positions and to set economic priorities that help shape future social conditions.
Speculators want both to beat the stock market game and to feel they are special in some way. Perversely, speculators often use the same mistaken procedures that others have used so they can feel somehow superior and prove themselves extraordinary. Do not fall prey to this losing impulse. Instead, learn what successful speculators have employed in the past to beat the stock market, as discussed here, and then feel comfortable using these time-tested winning techniques yourself.
Play To Win
To be a successful speculator requires the mindset to play to win rather than to take a strictly defensive position of playing not to lose. Buying seemingly safe stock, based on conventional wisdom or on surface conditions alone, is normally a terrible mistake. The fears of losing, looking silly and losing face are strong in all of us. However, letting these non-rational and irrational emotions dominate our speculative operations is speculative suicide.
One way to achieve speculative profits on Wall Street is to trade in good common stock and buy when no one else wants these shares and sell when everyone else does, i.e., simply be a nice person. Mayer Amschel Rothschild (1744-1812) perhaps says it best, “I buy cheap and sell dear.”
Astute speculators do no sit passively by and wait for something good to happen, instead, they train their eyes and/or ears to recognize opportunity coming just before it arrives. When you identify a stock market speculative opportunity, reach out and grab it. Accomplish this when speculating on Wall Street by reading, understanding and properly implementing the strategies and techniques presented.
Speculation: Both Art & Science
Stock market speculation is both an art and a science. The scientific method helps achieve the goal that science desires which is objective truth and knowledge. Human beings create art as a metaphor for life. Art is, or should be, imaginary or creative use of truth, knowledge and facts to produce subjective or desired social awareness, change or effect.
Art is most effective when artistically presenting something beautiful and/or entertaining, which seems more real and/or advantageous than reality. The goal is to persuade the audience to accept this artistic vision and take action. Accomplish the intended social progress by using an artistic approach that seems natural and does not draw attention to the art. Or as Cary Grant (1904-1986) says, “Art that is so artful, it’s artless.”
Astute speculators learn how to excel at both the art and the science of speculation. Scientific analysis for speculation in the stock market requires the study of the following eleven key speculative factors:
1) Knowing the difference between systemic risk versus unsystemic risk.
2) Knowing what stage the overall stock market is in and knowing the long-term stock market trend.
3) Determining whether the stock market is either undervalued or overvalued.
4) Yield curves, interest rate spreads and what affect they have on the stock market.
5) Knowing the political-economic conditions and how they affect the stock market.
6) Appreciation of human nature and trader psychology.
7) Understanding how the investing public responds to the news and discounting the news.
8) Knowing crowd psychology and when to be contrarian.
9) Intrinsic, true, or fair value and the margin-of-safety multiple calculations for common stock evaluation.
10) Understanding the discounted market hypothesis (DMH).
11) Identifying industry rankings and intermediate-term trends using turning points.
The Astute Investor presents all the eleven key scientific speculative factors by following the practical ten-step method for investment success, or also in this book.
The three speculative arts are necessary to becoming a successful stock market speculator. When mastered, the following speculative arts help ensure stock trading success:
1) How to time stock buying or short selling over the intermediate-term using turning points and trigger points.
2) How to sell or cover a stock position by taking the emotion out when using stop-loss orders and money management rules.
3) Knowing yourself and what plan will work best for you based on your character, personality and lifestyle.
Study the method for approaching and techniques for solving these three speculative arts so astute speculators can make money in the stock market. Internalize the practical approach to solving the three speculative arts. Mastering these speculative arts, while difficult, looks effortless to outsiders, and will allow astute speculators feel natural while trading.
Thinking Vs. Action
Divide people into those who delight in thinking and those whose main aim in life is action, which is “the soul of progress.” While the distinction often blurs, those who make the best speculators love to both “think and to act.”
Speculation is an intellectual pursuit requiring correct thinking and analysis and, as importantly, requires a person with energy who has the willpower to act properly at the right time. The successful speculator has self-control and manages his pursuits with ease. Correct method is the watchword. Do not rely on “luck.” To profit from stock market trends, fluctuations and changing conditions, you need to balance determination versus flexibility.
A Wall Street saying is appropriate, “Bulls make money, bears make money, but hogs get butchered.” It is careless to remain in a stock position beyond the cutoff point warranted by the risk entailed. However, there should be no reason to sell a stock that has done nothing wrong. Balance is key, do not overreach.
Accurate speculative theories are budding facts, the worth to the trader being solely in their appropriate application. For stock market speculators, Rene Descartes (1596-1650) puts speculative success another way, “It is not enough to have a good mind, the main thing is to use it well.” The correct application or proper implementation of the theory during trading is imperative.
There are an infinite number of ways to fail, but only a few ways to make something a success—especially in the competitive field of stock market speculation. How to find the winning approach that works best for you is next.
Winning In The Stock Market
Speculating in the stock market is a numbers game. Even if the speculator is an expert, only approximately six stock trades out of ten earn money. The requirement here is to let the winners run and only sell winning positions if the stock does something wrong, i.e., the stock behaves poorly. For the expected four out of ten stock losers, sell them quickly for small losses.
Speculators make the trends in the market and normally borrow money when going long and borrow stock when going short. As interest rates increase, the cost and therefore the difficulty in borrowing money triggers speculative sales, and when borrowing stock is a problem, this triggers speculative buying. Thus, the importance of knowing the stock’s float and how interest rates affect the stock market— discussed in the next chapter.
To be an astute speculator requires permanently graduating from the gambler class to the professional class, which requires using intelligent foresight, good judgment and following a written plan and schedule. Speculators who are correct in the stock market have two factors going for them: 1) the fundamentals of speculation; and 2) speculators who are wrong. Persons in other businesses or professions typically are poor stock speculators, as presented next.
Other Professionals Find Stock Speculation Difficult
Persons with commercial training and experience in other businesses or professions, e.g., mining, retailing, manufacturing, or the arts, and the legal, academic and medical professions all have difficulty translating their area of expertise into practical stock market success. Commercial business or knowledge in other professions does not automatically translate into success when buying and selling common stock, an example follows.
Enron Bankruptcy Example
Kenneth L. Lay, founder, chairperson, director and chief executive officer (CEO) of Enron Corporation presided over the second largest corporate bankruptcy in U.S. history, on December 2, 2001, of approximately $63 billion dollars. Lay is guilty on securities and wire fraud and conspiracy for lying to investors about Enron’s corporate well-being before its scandal-ridden collapse. Those responsible at Enron caused many billions of dollars of investor losses and took away the retirement savings and employment of their workers.
Reportedly, during Enron’s final months, Lay had most of his investments in Enron stock even though his financial advisers requested he diversify his holdings. During the trial, Lay’s defense said that fraud does not cause Enron’s failure but the stock’s downfall is because of short selling and bad news reports. Lay seems delusional, blames the messenger for his problems and when the castle-in-the-air perceptions (discussed in chapter 2) collide with the reality of a recession and bankruptcy—stock market reality clearly prevails.
What happened at Enron is inexcusable; management has a duty to know what is going on within their companies and to be forthcoming with shareholders. However, top businesspersons seem blind to their own business conditions, and know little about the stock market.
Insiders often hold on to their corporation’s stock even when it is clear to stock market professionals that selling their stock is advantageous. Lay probably remained overly optimistic about the company he founded and continued to maintain high expectations while fighting for Enron’s financial survival. Ken Lay did not see because he did not want to see and probably did not know what to look for in the stock market.
Consequently, the required undoing of the businessperson or professional’s current market beliefs and then special training are often necessary for success when trading in the stock market. Businesspersons in the financial services industry who keep up-to-date with interest rates, credit conditions, political trends and business conditions are typically the most successful part-time speculators.
Speculative Principles
The stock market is pure capitalism at work. Astute speculators should never think of the stock market as an overly friendly place where everybody wants everyone else to get rich, in fact with two sides to every trade, the truth is just the opposite. Instead, be a cynic concerning everyone’s motives and intentions in the stock market. The stock market game is merciless and played by professionals using survival instincts that are always complex and sophisticated.
Speculative professionals have the advantage when playing against the investing public, because, the investing public typically acts incorrectly at the worst possible time. However, the game balances out because professionals risk their great wealth by relying on their judgment of future political-economic conditions.
Speculators, whose actions keep enormous amounts of money vigorous, liquid and available, populate the stock market. Speculators, not investors, determine the intermediate-term trends in the stock market. To operate profitably, it is the speculators’ duty to direct funds to high value opportunities when purchasing stock, e.g., the best companies in the highest-ranking industries.
Speculative Goals: +33 Percent Per Year & Retain Profits
The basis of stock market speculation is to increase capital by exchange alone, without benefit of material or labor, which makes it an intellectual pursuit. Speculation requires theory formulation based on facts, assumptions based on observations, and conclusions based on correct premises and reasoned inference—concerning the underlying forces that determine future stock prices. This is the proper development of market foresight making the stock market a discounting mechanism.
The speculator’s approach, whether over the long-term or intermediate- term, is to be in step with the market trend by either purchasing or covering short positions on declines and selling or selling short on price bulges. This requires immense courage and ability to act at the right time based on knowledge and judgment.
A challenging but reasonable goal when speculating is to earn three times the average super-long-term S&P 500 Index return of approximately +11 percent per year, i.e., +33 percent per year. Try not to overreach, to expect to earn more than +33 percent per year, especially in the beginning of a speculative career, is unrealistic. Once earning the money, the second goal and real endgame requires retaining the profits by using stop-loss orders and money management rules.
Stock Market Imperfection
The stock market is an imperfect game; it is impractical to live up to a standard of perfection. Market timing, i.e., expecting to purchase common stock at the precise bottom price and to sell at the exact top price on any intermediate or long-term move is impossible. Speculators—do not chastise yourself for not being able to do the impossible. Feel comfortable in being close enough and attaining the more secure middle two-thirds in any market move.
Rather than expecting perfection in our stock market operations, think about predicting the future based on conditional probabilities. Astute speculators expect to put the probabilities in their favor before committing, but then live graciously with the results.
One achieves nothing by being greedy and attempting to secure 100 percent of the stock market gain on any intermediate or long-term move. Think of any price range movement as a yardstick—be content to capture the center twenty-four inches. The famous and incredibly successful speculator, Mr. Rothschild, never tried to time the exact bottom or top of a market move. Instead, he always wanted and planned for the more easily attainable middle two-thirds.
Keep The Mind Clear
Keeping the mind clear, balanced and unprejudiced is paramount for trustworthy judgment. To be successful in the stock market requires not fixating on the fear of losing. Outside pressures of fixed time limits, debt, or bills needing payment directs the speculator to attempt, either consciously or unconsciously, not to lose rather than to win which is a sure path to defeat. Stress clouds the mind and adversely affects trading performance.
A clear mind allows for speculative market-poise that is a belief and confidence that market action will result in a profitable outcome. A speculator with poise possesses dignity, equanimity and steadiness while dealing with the stress of emotional stock market circumstances.
As an example of an unclear mind, a famous speculator experiences continuous heavy losses, which unnerves him, and he cannot think clearly. He feels influenced by rumors, tips and outside pressures; therefore, he quarantines himself. He sends orders to the stock trading floor, but no communication from any outside source comes in to him, except through a stock tape machine. The isolation method works to clear this famous speculator’s mind and his profitable trades, as a result, resume.
Go Long Or Short, As Conditions Demand
To be an astute speculator requires the flexibility to go both long or short as market conditions demand. If speculators incorrectly feel they must be either long or short all the time, this makes them an underdeveloped one-way speculator. A biased long or short mindset makes speculators’ judgments unqualified because they now hold a preset long or short opinion.
Being either in a long or short position sways the speculator to that side of the market because, subconsciously, our judgment supports our actions. Instead, speculators should forget their current stock position. If long in a declining market, sell. If short in an upward trending market, cover. Only one speculator in a thousand is so proficient to conquer the effect that his or her long or short position in a stock exerts upon his or her judgment and resulting actions.
Human Impulses
Human impulses cause speculative calamities. Speculators should never act rashly or impulsively, but instead plan and schedule everything necessary to reach their speculative goals.
Successful traders have to control their feelings, disregard hopes, fears and greed and consistently follow a plan and schedule of operation that works for them. Think through speculative positions. Enter them unemotionally, with composure and forethought.