The Golden Rule in Investment

Buy before a rise in value; sell before a fall. This aphorism is worthy of a detailed attention, and may also be enunciated in the equivalent form: Act in the contrary way to that in which investors generally are acting at the time; that is to say, never buy when many are buying, but sell; refrain from selling when many are selling, but buy. Or we may thus phrase it: When people are decrying a security, buy, as a rule; when they are generally exalting it, as a rule sell. The dictum, of course, implies the permanent existence of foolish people and sagacious people, since if all investors adopted the maxim it would necessarily cease to possess a meaning, though, even then, sagacity would become like a thermometer, marked by degrees. But any speculation upon the possibility of a general state of wisdom can evidently wait. There is a contagion of hopefulness as well as one of depression; times when we fail to see things as they really are, but as they are shaped and modified by our fancies, fears and hopes; under the distorting influence of desires or aversions we form mental pictures which fail to portray the originals, for the "pathetic fallacy"of Ruskin is universal, and this abnormal condition of mind, like some physical ailment, is, as the phrase goes, wonderfully "catching."

When a lead is set, probably from no valid cause, in the direction of favour or disfavour of some particular investment, multitudes will irrationally follow to secure a portion of the fancied benefit, or escape the imagined loss, and thus aid in augmenting or depressing the value against their own interests. But the wise man remembers that in all human affairs no rise or fall can be continuous and without stay; success must follow failure, and failure, success, or neither could exist, and the descriptive terms, therefore, would become meaningless. The region of finance, like the phenomena of Nature, is equally subject to a rhythmic order.

Limit To Rise And Fall Of Securities

No security, obviously, from the nature of the case, can ascend or descend beyond a limited stage, the end of which (if it be an investment of any value) is marked by its yielding a rate of return about equal to the general remunerative rate; and the watchful man accordingly sells or buys as it appears to be verging on the limit of its ascent or fall. If the general rate of interest in sound securities be 3 per cent, the extreme points of value of an investment are indicated by its yielding this rate, taking of course into account any premium or discount (that is, the excess beyond or defect below the amount at which it will be redeemed, if repayable, or, if shares in a joint stock company, the sum paid up per share).

This golden rule has an admirable sound: but it is futile unless it is capable of being embodied in some practical workable shape. For all general rules are necessarily somewhat indefinite in character, - being deduced from concrete individual instances whence all irrelevant elements have been removed; and the application of them to actual cases, though never completely exact, furnishes the test of a man's superiority of sagacity and discriminate judgment. An explanation (so far as a decline in price is concerned) has been supplied by an author of ability, to the effect that when a person has been ill, the only way in which it can be discovered that he has passed the worst, or critical stage, and has started on the improving period, is the indications shown of his getting better. But this is a mere analogy; useful as a general illustration, but idle as a working criterion in other spheres of observation.

Analogies are constantly leading us astray, by being used as arguments in place of pictures, and the transfer from experiences in one department of thought or activity to another region with different phases and conditions forms one of our besetting sources of error. The truth must be gained in the set of facts in which it resides, and concrete illustrations in more familiar avenues of knowledge simply perform the function of enabling the truth to be more clearly perceived and comprehended. Analogies almost invariably limp on one foot or the other, and thus fail to bear us steadily and comfortably along. In the preceding illustration the very point at issue is assumed, - the existence of the clever detector of signs (like the physician), so that for the ordinary observer the analogy of disease is helpless.

How Can Highest And Lowest Prices Be Approximately Estimated?

Can, then, some pertinent interpretation be devised by which the ordinary man can detect, with reasonable exactness, the point when the possibly highest ascent has been attained, or is being attained, with the consequent time for sale, and the approximately extreme depression which suggests the advantage of a purchase ? This can only be attempted with approximation; and the right time will be grasped or lost according to the vigilance and knowledge of the spectator. The subject is complicated by the consideration that a fall or rise may exclusively be due to passing and temporary causes, and be in no way indicative of a sustained cause of movement.

It has been proposed that the monthly (middle) prices for a period in the immediate past (of the investment under inquiry) should be noted, when the average price can at once be deduced from these records; and when, in the near future, that average price is being passed upwards, the time for thinking of selling has arrived while this middle point indicates the approximate time to purchase as the present prices tend to fall below it. Two or three years at least should be employed in this record of prices for striking the average, in order to allow adequate time for the operation of all causes of inflation and depression, and thus secure an average datum of a fairly representative nature. A statement of quarterly prices (to save labour) may be reasonably used, - the urgent desideratum being that the survey of the past (which we thus constitute the guide to the future) should include a sufficiently long experience to express the effects of all the varying influences which affect prices. In reality, for the genuine indications of an average, a term of ten or eleven years should be chosen, since, looking to the course of what is named a cycle1 in commerce and trade, this time allows that extent of period (as repeated investigation discloses) for the presentation of the sequent (and recurrent) effects known as Depressed Trade, Healthy Trade, Excited Trade, with the culminations of a Bubble (or fictitious prosperity) and Collapse.