I’d like to tell you about a study I read recently.
It’s a slim little booklet titled One-Way Pockets by Don Guyon (a pen name for a broker). The book, which was first published in 1917, covers some studies he did on the trading behavior of accounts at the time. What he found was timeless.
The language is charmingly stuck in the World War I era. “At the fag-end of the never-to-be-forgotten ‘war brides’ market,” he begins, “I began, in a casual sort of way, to analyze the accounts of half a dozen of the firm’s most active traders.”
During the “war brides” market of 1914-15, defense stocks and industrials surged in response to the outbreak of World War I. [Editor’s note: “War bride” was a nickname for what we now call “defense stocks.”] But Guyon found that even though such stocks had already made large moves up, his firm’s clients had big stakes in them with small profits. This was not a unique circumstance. Guyon found that this was the way the top of every bull market looked, in his experience in the brokerage business. In 1917, there was a bear market, and these traders lost money.
This is where Guyon’s studies yield a few interesting results.
He looked at five leading stocks these accounts traded: United States Steel, Crucible Steel, Baldwin Locomotive, Studebaker Corp. and Westinghouse Electric. He analyzed the buy and sell decisions on each account and summed them up.
What he found was amazing. All of these stocks scored large gains during the war brides market. Yet “the average price at which each stock was bought for the six accounts was higher than the average price at which it was sold.”
Clearly, people bought them mostly after they had already gone up a bunch. Then they sold them when they fell.
Guyon did another study in which he looked at the order books of his firm’s accounts, plotting the buys and sells day by day from March 1916 to March 1917. A similar pattern emerged. The traders would buy a stock after the stock had risen. They would sell into declines. As Guyon wrote:
This analysis of transactions affords corroborative evidence of the same general trading faults that were revealed in the six accounts previously reviewed. Once again, the public sold too soon, repurchased at higher figures, bought more after the market had turned and, finally, liquidated on the breaks.
Tips, rumors, news — all these things Guyon thought only confused investors, pushing them to make emotional and ill-timed decisions. Guyon’s trading advice later in the book is not so useful, but the main point of his studies stands the test of time. The main point is simply that “the great majority of speculators are…consistent losers in Wall Street.”
Much of this reaffirms what is always true in the stock market. People chase price moves, rather than buy and hold (and sell) based on careful consideration of what they own.
People are also, everywhere, impatient. It makes me think of an old Far Side comic with two vultures sitting on a tree. If memory serves, one says to the other, “Patience, my ass! Let’s go kill something!”
Most people are like that vulture. They can’t wait. They need to “do something.” But as One-Way Pockets shows, “doing something” is often the wrong thing to do. Patience is better.
There are plenty of modern studies that find the same results as Don Guyon. Similar studies, yet more comprehensive, show how increased frequency of trading leads to poorer results relative to accounts with less activity. Other studies affirm that investors don’t even earn the stated returns on their mutual funds, because they take money out after it has done poorly (and the price is low), and add money when it has done well (and the price is high).
This is counter to all the good advice that is out there about investing from such greats as Warren Buffett, Peter Lynch, Seth Klarman, Martin Whitman and others who preach the virtues of buying cheap and holding on. It’s all out there, and you can acquire a first-class education about good investing for very little money. Yet, as Guyon writes, “These venerable Wall Street ‘dos’ and ‘don’ts’ have always reminded me of the ‘Stop! Look! Listen!’ signs encountered on a day’s motor trip, whose number and sameness cause them to be disregarded.”
I don’t know about you, but I find these things endlessly fascinating. That a man writing in 1917 could speak to us so clearly and usefully is one of the charms of markets. No matter what time or place, people are people, markets are markets, and they seem to behave in a universal manner.
Therefore, if we know what kind of behavior loses, we should do something different if we want better results. That would be picking up beaten-up stocks and riding them, rather than trying to guess at price movements and jump in and out of them.
So I’d urge you to be patient with your stocks. In my investment service, Mayer’s Special Situations, I have recommended a select group of promising stocks with tremendous upside potential. Not all of them will work out, of course. But as a portfolio, I think we will continue to have some big winners over the years.