The Psychology of the Stock Market

Most experienced professional traders in the stock market will readily admit that the minor fluctuations, amounting to perhaps five or ten dollars a share in the active speculative issues, are chiefly psychological. They result from varying attitudes of the public mind, or, more strictly, from the mental attitudes of those persons who are interested in the market at the time.

Such fluctuations may be, and often are, based on “fundamental” conditions—that is, on real changes in the dividend prospects of the stocks affected or on variations in the earning power of the corporations represented—and again they may not. The broad movements of the market, covering periods of months or even years, are always the result of general financial conditions; but the smaller intermediate fluctuations represent changes in the state of the public mind, which may or may not coincide with alterations in basic factors.

to reproduce a conversation between professional traders such as may be heard almost any day in New street or in the neighboring cafés.

“Well, what do you know?” says one trader to the other.

“Just covered my Steel,” is the reply. “Too much company. Everybody seems to be short.”

“Everybody I’ve seen thinks just as you do. Each one has covered because he thinks everybody else is short—still the market doesn’t rally much. I don’t believe there’s much short interest left, and if that’s the case we shall get another break.”

“Yes, that’s what they all say—and they’ve all sold short again because they think everybody else has covered. I believe there’s just as much short interest now as there was before.”

It is evident that this series of inversions might be continued indefinitely. These alert mental acrobats are doing a succession of flip-flops, each one of which leads up logically to the next, without ever arriving at a final stopping-place.

Soon another unostentatious upward movement begins, carrying prices a trifle higher than the first. A few shrewd traders take the long side, but the public is still unmoved and the sleeping short interest—most of it originally put out at much higher figures—still refuses to waken.

Gradually prices harden further and finally advance somewhat sharply. A few of the more timid shorts cover, perhaps to save a part of their profits or to prevent their trades from running into a loss. The fact that a bull turn is coming now penetrates through another layer of intellectual density and another wave of traders take the long side. The public notes the advance and begins to think some further upturn is possible, but that there will be plenty of opportunities to buy on substantial reactions.

Strangely enough, these reactions, except of the most trifling character, do not appear. Waiting buyers do not get a satisfactory chance to take hold. Prices begin to move up faster. There is a halt from time to time, but when a real reaction finally comes the market looks “too weak to buy,” and when it starts up again it often does so with a sudden leap that leaves would-be purchasers far in the rear.

What the speculator sells he or some other trader may buy back tomorrow.

The time comes when everybody seems to be buying. Prices become confused. One stock leaps upward in a way to strike terror to the heart of the last surviving short. Another appears almost equally strong, but slips back unobtrusively when nobody is looking, like the frog jumping out of the well in the arithmetic of our boyhood. Still another churns violently in one place, like a side-wheeler stuck on a sand-bar.

Then the market gives a sudden lurch downward, as though in danger of spilling out its unwieldy contents. This is hailed as a “healthy reaction,” though it is a mystery whom it can be healthy for, unless it is the shorts. Prices recover again, with everybody happy except a few disgruntled bears, who are rightly regarded with contemptuous amusement.

Curiously, however, there seems to be stock enough for all comers, and the few cranks who have time to bother with such things notice that the general average of prices is now rising very slowly, if at all. The largest speculative holders of stocks, finding a market big enough to absorb their sales, are letting go. And there are always stocks enough to go around. Our big capitalists are seldom entirely out of stocks. They merely have more stocks when prices are low and fewer when prices are high. Moreover, long before there is any danger of the supply running out, plenty of new issues are created.

It is hard for the average man to oppose what appears to be the general drift of public opinion. In the stock market this is perhaps harder than elsewhere; for we all realize that the prices of stocks must, in the long run, be controlled by public opinion. The point we fail to remember is that public opinion in a speculative market is measured in dollars, not in population. One man controlling one million dollars has double the weight of five hundred men with one thousand dollars each. Dollars are the horse-power of the markets—the mere number of men does not signify.

This is why the great body of opinion appears to be bullish at the top and bearish at the bottom. The multitude of small traders must be, as a plain necessity, long when prices are at the top, and short or out of the market at the bottom. The very fact that they are long at the top shows that they have been supplied with stocks from some source.

Again, the man with one million dollars is a silent individual. The time when it was necessary for him to talk is past—his money now does the talking. But the one thousand men who have one thousand dollars each are conversational, fluent, verbose to the last degree; and among these smaller traders are the writers—the newspaper and news bureau men, and the manufacturers of gossip for brokerage houses.