Daniel Defoe, the writer of Robinson Crusoe wrote a book about avoiding the pitfall of investing in the stock market.
It was called The Anatomy of Exchange Alley. In 1700 trading in stocks was considered a scandalous and knavish trade and treason in its impact on the public.
So it can be said that even 213 years ago the stock market was considered dicey.
Today that opinion remains.
You would have thought that given 213 years, the advent of the industrial revolution and untold social and political developments that society in general would have got its head around investing in stocks.
Meanwhile America kicked out the British, France’s population managed to decapitate its King, electricity got discovered, hygiene mastered and the world population increased from 600 million to 7 billion, you would have thought the mysteries of buying and selling shares would have been grasped, harnessed and controlled like flight or minor surgery.
As such investing today should be as safe as flying in a commercial airliner or have a mole removed.
But it isn’t.
Investing or speculating is a fraught as it ever was.
Why?
Some financial mistakes seem eternal.
Here are another five, extracted from “Letter from my Broker,” written in 1919.
Here are 5 more classic ways that have skewered traders for over 300 years.
Penny stocks are cheap myth.
“Low priced stocks are cheap, high priced stocks are expensive.”
Time and again people say penny stocks can go up easily by huge percentages where as a Google or Apple with fat multi-hundred dollar prices cant.
This is why penny stocks are so popular. People think a penny stock is cheaper than a stock at $50. They mistakenly equate price with value.
Many people will find this hard to believe that people really think this but if you doubt it, consider stock splits.
I know what some people are going to say, it is about liquidity. Well in London its not $100 which makes investors sweat about the price being too high, its $1.50 and most certainly at $15. Many investors even professionals still think a high nominal is low value. Don’t believe it however much you want to.
What is equally wrong is some professional investors think a low price intrinsically indicates low value.
Getting it upside down.
With most things in life, people buy when the price goes down and refrain from buying when the price goes up. In the stock market the opposite is true. There is nothing more attractive to many speculators than a rapidly rising stock. That is like going to the store and buying lots of onions because they put the price up today. It is like avoiding onions because they are on sale. In real life you wouldn’t do that. In the market it happens constantly.
Of course we know why this happens but we should also know why that’s a trap.
However whether it was Tulip bulbs or Radio shares or dotcom stocks or Tesla, investors can’t resist buying what has just shot up. They also cant resist selling in panic when the price is tanking.
When you feel this whiplash yourself in your portfolio, it is time to invest differently.
Give me leverage!
Leverage kills. At the turn of the 19th century the bucket trading shops relied on leverage to fleece their clients. How? Was it some sleight of hand fraud?
No.
Simply, high leverage plus tight stop losses, equates to guaranteed failure. So when a broker offers you big leverage and advises you to make tight stop losses, they are really asking you to pump all your capital into their bank account.
Bucket shops offered a $2 margin and a $2 stop loss, but as the volatility was sufficiently high, chances of the stop losses not being triggered were minimal.
However you don’t have to be a victim of a legal crime to see leverage doing its financial destruction. Whereever there is a big bust, there will be the devil of leverage grinning away.
How is it that leverage could ever make more money?
If it did people would lever up to the moon and become infinitely rich. History teaches us the opposite is true.
People take notice of the words not numbers.
Few traders or investors study the fundamental numbers that represent the value of a company.
Instead they listen to stories.
They read the newspapers, watch the TV, listen to the radio but practically avoid the company’s balance sheet. You can probably forgive a fop in the 1600’s with more opportunities to wear powdered wigs and drink coffee with no access to data from listening to the narrative but by 1919 you could get access to financial information. Today there is a blizzard of it. Yet for every 1 person doing their own quantative research there are ten hooked on gossip.
You can take the market out of a coffee shop but you can’t take the coffee shop out of the market.
Roll the dice.
Gambling was a plague in the 1700s. Fortunes were lost on gambling, families ruined. Many gamblers were cheated even while they lined up to be fleeced by the odds.
Gambling remains the short cut to ruin even today.
Today as it was in 1919 and 1719, many people are not investing in stocks, they are gambling using the status of investing as a front for their thrill seeking.
If you are not investing for the long term, hedging or illegally cheating for illicit profits, you are gambling.
People imagine that big banks make money from trading because they are smart, so they might be able to do it too. But these big trading firms are gambling and they go bust. That is what 2008 was all about. It doesn’t matter how big you are, if you gamble you lose.
Most people do not realise they are gambling when they trade stocks. This is root of there loses.
Jesse Livermore and his escapades in the 1923 classic Reminiscences of a Stock Operator are a seductive narrative but we must read on. He lost his winnings several times and ended up shooting himself.
History tells us again and again, don’t gamble on stocks, you will lose, knave or no knave.
Yet it is not all bleak but the first rule in any endeavour is stop doing the stupid stuff, then work from there.
There is plenty of money to be made investing, after all, such a high proportion of the participants are throwing theirs away believing dumb myths and that leaves potential to profit by being sensible.
Joe in “Letter to my Broker,” says, “give me some advice, not that I’ll take it.”
As such a book written in 1919 will likely be as relevant in 2113 as it is today.