“There is overwhelming evidence that speculative operations conducted in even the best securities on insufficient margins, on erroneous conceptions of values — particularly future values, or in opposition to economic conditions and prospects, will inevitably result in loss in the long run,” he wrote in his book “Basic Principles of Speculation.”
Gibson said a major mistake made by most investors is that they try to call every market turn which is a tactic that has very little chance of success as not only is there a tendency to lose perspective in attempting to call every trend reversal, but also investors invariably exhaust their objectivity and ultimately lose touch with the market.
Thomas Gibson was a prolific writer who authored several books on investment and speculation.
According to Gibson, any investor with average intelligence should realize and admit that the best time to purchase securities is when prices are depressed, not when they are inflated.
Gibson said still the great bulk of public buying of securities is done at the approximate top of a major cycle of prices, while most of the selling is done when prices are very low.
Causes of speculative losses
Gibson listed the factors that are responsible for speculative losses which are:
1. Buying at high prices after a major advance.
2. Operating on insufficient margins or overspeculating.
3. Relying on tips and “market appearances.”
4. Relying on charts or similar systems.
5. Using stop-loss orders.
6. Impatience and inability to await results
7. Psychological effects of greed and fear.
Gibson said greed is responsible for over-speculation, lack of discrimination in the selection of securities, and is a synonym for impatience.
Also, he said fear causes investors to sell when prices are low and prevents investors from buying when securities are intrinsically cheap.
Gibson said the most common error that investors make is that they assume that present conditions will be indefinitely projected into the future.
Avoid Over-speculation
Gibson said over-speculation eventually ruins any investor’s portfolio who indulges in it.
“He may escape for a time and he will usually resolve that after the present deal is carried through he will be more conservative. But it works the other way, for each success makes the operator bolder and the first reversal will wipe out previously acquired profits,” he says.
Gibson said unexpected reversals are certain to appear at times and no amount of vigilance or study can provide against this contingency and the only thing which can insure a reasonable degree of safety is a sufficient margin or sufficient reserves at all times.
Avoid investing on the basis of stock tips
Gibson said investors who enter the stock market with tips as their basis of operations will never succeed.
According to Gibson there can be only one sound reason for purchasing or holding securities, and that is because they are cheap.
“If the buyer knew they were cheap he would surely not order them sold if they became cheaper,“ he said.
Reasons for losses in speculative ventures
Gibson said the errors springing from ignorance, greed and fear are responsible for most losses in speculative ventures.
“One of the peculiarities in connection with greed is that a speculator will frequently over-extend himself and endanger his entire capital in order to hasten the process of accumulating profits when there is no reason for haste,” he says.
Treat opportunities as irregular occurrences
Gibson said mistakes are made when opportunities in the market are treated as rare rather than common irregular occurrences.
Gibson said there is more chance of a wide price movement in a mystery stock than in a stock which can be competently analysed.
Gibson said experienced and far-sighted investors buy securities because they have reasons to believe that profits will soon increase. On the other hand the inexperienced public speculator sees no reason for buying at such times, as surface appearances are discouraging.
Accept losses
Gibson said the inability to accept a loss is one of the most common and most mischievous of the numerous errors found in connection with operations in the security markets.
Avoid sticking to a bad trade
Gibson said investors have a habit of sticking to a bad trade in the mere hope that its fortunes will turn around in the future.
He said an inexperienced speculator is likely to magnify the probability of profit and minimize the probability of risk to allow hope to outweigh judgment.
“Every man, whether he be an investor or a speculator should school himself against this habit of sticking to a bad bargain in the mere hope that something will happen to bring him out whole. The habit is illogical and expensive, and I regret to say that it is quite prevalent,” he said.
Stick to common sense
Gibson said that common sense is the most uncommon of all human attributes.
“Its possession and exercise calls for labor, reflection, self-denial and courage,” he said.
Examine earnings over a period of years
Gibson said the results secured by a firm for a single year do not form a safe basis for estimating values.
He said sometimes great profits are rolled up rapidly because of abnormal conditions, coupled with mere luck.
“The progress of earnings should first be examined over a period of years, care being taken to iron out and disregard abnormalities except in so far as they may favorably or unfavorably affect the cash or asset position of the corporation under review,” he said.
Avoid being too greedy
Gibson said most investors have such a strong ego that they flatter themselves and feel that they would make great profits in a short period and feel they are wise enough to keep the profit.
But according to Gibson this isn’t always possible as it is not in human nature that it should happen.
“A man who is bold enough to plunge in such a way as to turn a small amount into a large amount in a short time does not suddenly become conservative. We cannot endow the individual with two antithetical natures,” he says.
Qualities of a successful speculator
Gibson said a successful speculator maps out an intelligent and well-founded plan of operation, contemplating all that may occur, and having mapped it out, follows it.
Gibson said very few speculate in this manner, and hence very few succeed.
“The man who speculates in a business-like way trades only in standard properties with whose history, physical condition, earnings, and prospects he has thoroughly familiarised himself; forms for himself a careful estimate of normal value and uses this value as a gauge by which to decide when prices are too low and too high; takes into consideration also the technical condition of the market, and does not embark with bad company, even at low prices; is not misled by the thrills of inflation, or the chills of depression; operates, not for the purpose of gathering a small profit from many transactions, but to gather a large profit from a few; trades with responsible middlemen, and, above all things, is patient,” he said.
Importance of valuation
Gibson said the great basic principle of speculation, the foundation upon which the entire structure rests, is the recognition of value.
“No sustained success is possible without this knowledge, and most failures are traceable to the lack of it. Yet so generally is this important element disregarded, or refuted, that we find it playing only a small part, or no part at all, in the operations of the average speculator,” he said.
Have reasonable expectations
According to Gibson speculators consider ten per cent a good return on capital in ordinary business but are wholly dissatisfied with one hundred per cent return in a speculative venture.
“The man who speculates in a business-like manner will at once see the necessity of entirely eliminating abnormal possibilities and rashness from his plan of operation. The difference between expecting from the market what is reasonable, and expecting too much; and between buying what can be reasonably protected, and even increased, and plunging, is exactly the difference between success and failure,” he said.
When to sell
Gibson said it is necessary to check the estimated and fixed value of the stocks traded in and find out how much above this normal point the shares are selling.
“Common sense, plus prudence, and minus piggishness, may determine the question and dictate the time for liquidation. This action, however, once decided upon must be adhered to with great rigidity, for thousands of traders who thus take time by the forelock have been dissatisfied afterward by seeing a still greater advance in which they had no interests, and through greed and impatience have re-entered the lists at a most inopportune time,” he said.
Don’t Overtrade
Gibson said many investors with sound ideas falter because of over-trading and become paupers, when they with their correct business methods could have become millionaires.
(Disclaimer: This article is based on Thomas Gibson’s book “Basic Principles of Speculation”)