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The Art of Speculation – Philip Carret
June 8, 2007, 3:20 pm
Filed under: investments/finance/economics

Notes taken off The Art of Speculation by Philip Carret

The Wit and Wisdom of Philip Carret

  • Even in the highest-grade securities there is a certain inescapable speculative risk. It is not decreased by burying one’s head in the sand like an ostrich and saying, “I never speculate!”
  • Just as water always seeks its level, answering the pull of gravity, so in the securities markets prices are always seeking a level of values.
  • Limitless horizons stretch before the would-be speculator.
  • During a period of persistently declining prices a novice asked Russell Sage whether he though stocks would rally. “They always have,” was the laconic response.
  • Like the ocean, the stock market is never still.
  • Reference has already been made to the timidity of the average trader in the face of a profit, his stubbornness when faced with a loss. The explanation is probably to be found in the tardiness with which the mind adjusts itself to changing ideas of value.
  • The regularity with which a long-sustained movement in one direction has been followed by a long-sustained movement in the reverse direction is striking.
  • As good an explanation as any is the inability of the majority of mankind to maintain a regimen of hard work in the face of easy living conditions.
  • The silk-shirt era of 1919 and 1920 was followed by the painful depression of 1921. So it has been throughout the history of the world.
  • An overdose of rising priceshas the ultimate effect as an overdose of any stimulant.
  • The demand for fresh eggs for the table is a fairly constant phenomenon. Hens show a fine disregard for human appetite, however, and vary the intensity of their efforts with the seasons.
  • The fact that the average trader abuses credit is no argument against the use of credit in stock market speculation. For the trader who borrows in moderation, credit is a very useful tool.
  • Most traders are optimists by nature and therefore buyers rather than sellers of stocks.
  • Beyond a certain point which can be designated with some assurance, a bull market nevertheless resembles the octogenarian who is living on “borrowed time”. It may have months yet to live but it is increasingly a poor risk.
  • It is now possible to define “technical position”. Briefly, it is the ratio of stocks in strong hands to stocks in weak hands.
  • Fortunes are usualy made by expansion of values, not by their destruction.
  • If the amateur finally decides to leave short selling to those who make speculation their business, it is likely to be a profitably decision.
  • Fashions play their part in the stock market as in other affairs of life.
  • Finance has its anatomy and its physiology. The former is studied through the medium of balance sheets, the latter through income statements.
  • The speculator interested in a mine in the development stage is prone to underestimate the time necesary to bring it to profitable production.
  • Puts, calls, spreads and straddles are a mysterious subject to the ordinary speculator in spite of the fact that they afford one of the best possible media of gambling on a shoe-string with any chance of success.
  • One of the essential qualifications of the successful speculator is patience.
  • Applied to individual stocks, price earnings ratios in themselves mean nothing.

Prosperity contains the seeds of its own destruction.

Speculation is no simple business. The amateur cannot take a few thousand dollars’ capital, fiften minutes a day of time, treat it as side-line and be any more successful than he would be in any other business. Indeed, speculation requires broader knowledge, closer attention, sounder judgement than the average business. Prices on the New York Stock Exchange are affected by French politics, German banking conditions, wars and rumours of wars in the Near East, the Chinese money market, the condition of the wheat crop in The Argentine, the temper of the Mexican Congress as well as by a host of domestic influences. The successful speculator must carefully weigh the effect of all these influences, set down the pros and cons and arrive at a sound conclusion as to the side on which the balance lies. When he has done all this, he has made only a beginning. If he concludes that the balance favours an upward movement, he must still decide which stocks he is to buy for maximum profit.

Weak hands vs. strong hands

Weak hands refer to margin traders; strong hands are long-term investors and institutions. Carret defines technical position as the ratio of stocks in strong hands to stocks in weak hands.When the proportion of stocks in strong hands is abnormally high, the market may safely be said to be in strong technical position. A tendency for stocks to leave strong hands and pass into margin accounts weakens the technical position of the market.

To be successful, the speculator must know a great deal more than merely enough of general conditions to determine the trend of the general market. He must be a student of values in individual securities. To appraise values in individual securities he must know something about a great many different businesses. He must know in a general way the trade practises in the rubber industry, understand the colono system in the sugar industry, be familiar with depreciation practices among the public utilities, appreciate the significance of ton-miles and many other technicalities of railroading. Anove all, he must know something of accounting. He must study financial statements as intently as the banker does those of the applicant for credit, though from a different view point. The question of ascertaining trend of the market is important to the speculator, but it should not rank any higher in importance than the question of intelligent selection of his vehicles.

The Twelve Commandments for Speculators

  1. Never hold fewer than ten different securities covering five different fields of business.
  2. At least once in six months reappraise every security held.
  3. Keep at least half the total fund in income-producing securities.
  4. Consider yield the least important factor in analyzing any stock.
  5. Be quick to take losses. reluctant to take profits.
  6. Never put more than 25% of a given fund into securities about which detailed information is not readily and regularly available.
  7. Avoid “inside information” as you would the plague.
  8. Seek facts diligently, advice never.
  9. Ignore mechanical formulas for valuing securities.
  10. When stocks are high, money rates are rising, business prosperous, at least half a given fund should be placed in short-term bonds.
  11. Borrow money sparingly and only when stocks are low, money rates low or falling, and business depressed.
  12. Set aside a moderate proportion of available funds for the purchase of long-term options on stocks of promising companies whenever available.
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