Scientific Stock Speculation

Scientific Stock Speculation: An Oxymoron?

Scientific Stock Speculation

“The public as whole, buys at the wrong time and sells at the wrong time.”

                                                --Charles H. Dow

Having just published this article on how poorly the general public has fared in its timing of the market, we found the above quote to be quite relevant. We encountered it in a first edition printing of Scientific Stock Speculation by Charles H. Dow, one of the founders of Dow Jones & Company and the creator of the oldest widely followed stock index, the Dow Jones Industrial Average. In 1902, he wrote a series of articles for his newspaper, the Wall Street Journal, on the “science” of stock speculation. These articles were compiled into the book in 1920 by G.C. Selden. It is a little bit ironic that only two years prior to when Dow wrote the articles, the French mathematician Louis Bachelier published his landmark thesis “The Theory of Speculation” which concluded that the expected return of speculation is zero before costs (which implies negative after costs). However, a careful reading of Dow’s articles suggests that what he meant by “scientific speculation” was actually investing.

Dow eviscerated the idea that professionals have some special ability to time the market when he said, “The fact is that people in Wall Street, even those who get very near the center of large operations, do not know what the market is going to do with any regularity or certainty.” He actually belittled the idea of speculation when he remarked, “Money is made by conservative trading rather than by the effort to get large profits by taking large risks…Most people, however, when they talk about making money in stocks do not mean the slow road through investments but the short cut by way of speculation.” Dow put the final nail in the coffin of getting rich quickly through speculation when he opined, “the outsider who will wisely study values and market conditions and then exercise patience enough for six men will be likely to make money in stocks.” He spelled out his meaning as clearly as possible when he said, “If people with either large or small capital would look upon trading in stocks as an attempt to get 12% per annum on their money instead of 50% weekly, they would come out a good deal better in the long run.” Perhaps Dow’s 12% can be thought of as a market rate of return plus a few percent for being a liquidity provider to other traders.

Benjamin Graham, the father of value investing, once said, “In the short run, the market is a voting machine but in the long run, it is a weighing machine.” We believe he may have been pre-empted by Mr. Dow who said, “In the long run, the prices of stocks adjust themselves to the return on the investment—the tendency of prices over a considerable length of time will always be towards value.”

Although Mr. Dow was one of the founders of the financial media, he essentially counseled investors to ignore it when he remarked, “Wall Street is often full of people today who have been long of the market for a month, but who have made little or no money, because they have been scared out by rumors and by small relapses. The man who does not see the market escapes this.” We at Index Fund Advisors would happily credit Mr. Dow with being the inspiration for our own Step 12—Invest and Relax. To conclude, although Dow may have used the term “speculation” due to its popularity at that time, his obvious goal was to transform the public from speculators (day traders operating in bucket shops) to genuine investors.