Trading Insights from ‘The Battle For Investment Survival’

INVESTOPAPER

‘The Battle for Investment Survival’ was written by Gerald M. Loeb in 1935. Gerald Loeb was a founding partner of E.F. Hutton & Co., a renowned Wall Street trader and brokerage firm. The book highlights the importance of preservation of capital through cutting of losses and emphasizes trading/speculation over investment.

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Here, we have compiled some of the thought provoking excerpts from the book. Hope, it is useful.

Trading Insights From ‘The Battle For Investment Survival’

— Storing present purchasing power for use in the future is investing, no matter in what form it’s put away.

— Willingness and ability to hold funds un-invested while awaiting real opportunities is a key to success in the battle for investment survival.

— Accepting losses is the most important single investment device to ensure safety of capital.

— Any investment policy followed by all naturally defeats itself. Thus, the first step for the individual really trying to secure or preserve capital is to detach himself from the crowd.

— It is absolutely futile to try to get results except by buying into anticipated large gains. It is far better to let cash lie idle than to buy just to “keep invested” or for “income.”

— Trades should never be closed unless a good reason is at hand. But many “long-pull” traders ignore a sign of a change of trend because they feel it is temporary. Often they are right but eventually they are wrong, and usually at great cost. The short term method requires the closing of the trade for a reason, and if later the situation changes, then one can re-establish the position.

— In my opinion, commitments should not be closed haphazardly or, even worse, allowed to remain open without justification. For example, one might be convinced that a quick move was in prospect for a particular leader. This being the case, the stock is bought for a quick move, and if the move fails to develop in the anticipated direction quickly, the stock should be sold. When it was bought, no thought was given to its value other than as a medium for a quick trade; hence, it should not be held later as an “involuntary investment.”

— Large commitments, meaning thereby a few relatively large blocks of shares, are preferable to a great many small positions. These few large holdings may total only 30% of funds available at the moment. However, confining oneself to situations convincing enough to be entered on a relatively large scale is a great help to safety and profit. One must know far more about it to enter the position in the first place, and one will retreat from a mistake much quicker if failure to retreat means an important loss. A large number of small holdings will be purchased with less care and ordinarily allowed to run into a variety of small losses without full realization of the eventual total sum lost. Thus overdiversification acts as a poor protection against lack of knowledge.

— When an investment is made, its prospects must be so good that placing a rather large proportion of one’s total funds in such a single situation will not seem excessively risky. At the same time, the potential gain must be so large that only a moderate portion of total capital need be invested to get the desired percentage appreciation on total funds.

— Once you attain competency, diversification is undesirable. One or two, or at most three or four, securities should be bought. And they should be so well selected, their purchase so expertly timed and their profit possibilities so large that it will never be necessary to risk in any of them a large proportion of available capital. Risks are reduced in two ways-first, by the care used in selection, and second, by the maintenance of a large cash reserve. This policy involves not only avoiding diversification but also at times holding one’s capital un-invested for long periods of time.

— A stock widely held by investment trusts is not a good reason for buying, as such stocks are generally of the high-grade kind difficult to buy cheap. The distinction of being the stock most frequently listed in published institutional holdings simply means not only that the price is probably high rather than low but also that there is a large number of potential sellers should the situation take a turn for the worse.

— As soon as a security is purchased, the buyer loses the power to avoid a decision. It becomes necessary for him to decide whether to hold or sell. When nothing but cash is held, no decision need be made at all unless conditions are completely satisfactory. Either a suitable opportunity may be present, so that a purchase can sensibly be made, or the pros and cons may be so balanced that nothing is done. The worst that can happen if the latter decision is reached is that an opportunity will be missed through caution, which is an inconsequential misadventure. Other opportunities always come in due time.

— A reason why selling at the right time is more difficult than buying is that the development of a frame of mind in which only real bargains are sought carries with it a tendency to lose confidence too early. Periods of overvaluation and public overconfidence are, naturally enough, likely to follow periods of depression, and often do. Likewise, very good general business conditions will normally succeed very bad conditions. In such active periods, stocks will sell at excessive valuations, so that their price advances will often outrun the most optimistic expectations of those who bought very early and very low. The latter will begin to feel uncomfortably unsure of their position as soon as normal valuations arc restored, or when the indications of overvaluation are first to be seen.

— Losses must always be “cut”. They must be cut quickly, long before they become of any financial consequence. After the elimination of a stock in this manner, the transaction must be, in a sense, forgotten. It must be left out of future consideration so completely that there is no sentimental bar to reinstating the position at higher level, either very soon or at any later date, if the purchase again seems strongly advisable.

— Cutting losses is the one and only rule of the markets that can be taught with the assurance that it is always the correct thing to do. People like to take profits and don’t like to take losses. They also hate to repurchase something at a price higher than they sold it.

— It is advisable always to keep un-invested reserve funds on hand in order to take advantage of unexpected opportunities. The need for buying power in such cases may in itself be a factor dictating the sale of securities already held.

— Belief that a stock is in a buying range justifies a small initial purchase. If the stock declines, it should be sold at a small and quick loss. But if it advances and the indications which supported the original purchase continue favorable, additional purchases can be made at prices which the buyer still considers abnormally low.

— Shares have a habit of sometimes seeming dear in the early stages of an advance, and later at far higher levels new and unexpected developments often make them seem cheap again.

— The most important single factor in shaping security markets is public psychology. I feel that the psychology which leads people to pay forty times net (to use that yardstick for an example) for a stock under one set of conditions and refuse to buy the same shares under another set of conditions at ten times is such a powerful and vital price changing factor that it can overshadow actual earnings trends as an influence on stock prices.

— Theorists may claim that “stocks are too high” or “too low” based on their individual and varying idea of what people should pay for a given situation at a given time. But the real price of stocks is based on the majority appraisal of the moment. If the public’s pocketbook is longest and widest open, their appraisal goes for a time anyway.

— When you buy a stock you expect to resell it higher; hence you definitely want one that is likely to be easy to resell and that has a natural market. Certainly you do not want an issue whose price partly depends on the creation of an artificial demand.

— In fact, the smart trader pyramids on new highs; the uninformed one “averages.” There is something about new highs that makes them look unfamiliar and dangerous to the tyro. The first time an issue sells at 20, 25, 30, 35, 40, 45, 50, 55, it looks very risky. But after 55 then 49 looks safe and secure. Thus most “distribution” is done “on the way down.”

— The right way to do it is to pyramid. I have a buying power of 1,000 shares. I think Studebaker is going up. I buy 100 shares. It doesn’t go up when it should, or worse, goes down, I sell it out. The loss can be charged to insurance, or experience, or as necessary cost of getting started right. Next, I buy 100 Chrysler. It begins to advance as I anticipated. So I buy 200 more. It still does well, so I buy another lot. And so on. First thing you know, if it’s good I am long a big line of the right stock with a small initial risk. I lost only on 100 shares in Studebaker; I risked only 100 in Chrysler. If these principles were always practiced, one would always be long the right quantity of the right stock, because the measure of what stock to buy and how much of it to buy is the action of the market itself.

— Some very great fortunes have been made by holding some favorite stock through thick and thin. But that is not the question. How many have been made through chance and how many through judgment? I think most of them by chance, coupled with certain other qualifications, definitely rarely by judgment.

— Know you are right and go ahead. If in doubt, stay out.

— Stocks that are high and going higher are a good buy. Stocks that are “cheap” and growing cheaper don’t interest me from a buying angle.

— I think almost regardless of the account, I’d sell 10% of it every year. I say 10%, but maybe it ought to be 20% or more. What I mean is that I would always try to keep an account fresh and growing and in the live issues of the day and not in a lot of frozen back numbers. About the best way to do it is to sell a portion every year, more or less automatically. If reasons don’t develop for doing this, then just sell for the sake of selling.

— There is nothing more difficult to practice than accepting losses. This is especially important because there are bound to be times when you sell something and it turns right around and goes up. There is only one way to look at it and that is to think of the costs of selling at the wrong time as comparable to an insurance premium.

— The majority of people have been taught to believe in the sanctity of assured income and somehow brought to think that if they watched fluctuations in the values of their investments, they were “speculators.” The fact that dividends have been paid for many years back is in itself no guaranty that they may not be reduced or discontinued in the future with consequent decreasing or vanishing of income, plus capital losses realized or unrealized.

–The intelligent and safe way to handle capital is to concentrate. If things are not clear, do nothing. When something comes up, follow it to the limit, subject to the method of procedure that follows. If it’s not worth following to the limit, it is not worth following at all. My thought, of course, is always start with a large cash reserve; next, begin in one issue in a small way. If it does not develop, close out and get back to cash. But if it does do what is expected of it, expand your position in this one issue on a scale up.

— The greatest safety lies in putting all your eggs in one basket and watching the basket. You simply cannot afford to be careless or wrong. Hence, you act with much more deliberation.

— “Stocks were made to sell.” “Let the buyer beware.”

— Eventual profits and often real fortunes are built by buying at the turning points of great depressions. However, unless cash is on hand to buy bargains these opportunities cannot be utilized.

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