For Novice Speculators, Some Guidelines Apply

Buy and hold. Buy and hold. Buy and hold. If only you had a nickel for every time some market “expert” was quoted saying that small investors don’t trade stocks well, and that active trading should be left to professionals.

Individuals should buy and hold, buy and hold, buy and hold.

That has been Wall Street’s mantra forever, and tens of millions of Americans have dutifully complied.

But as Times staff writer Walter Hamilton chronicles in today’s section, buy and hold simply isn’t good enough anymore for a growing number of small investors.

For reasons that have as much to do with basic human nature as anything else, thousands of people have jumped into the “day trading” game, which typically involves rapid-fire transactions sometimes totaling in the hundreds in a single day.

These traders are a small minority, as Hamilton also points out. But we know that many other investors have caught a less virulent form of the trading bug over the last few years. The Internet stock mania has crystallized this phenomenon, though it probably would have happened even without the Net stocks.

We’re dealing here with the “technological imperative,” which physicist Sir John Polkinghorne has described as “Come on, if we can do it, let’s do it and see what happens.”

Advances in trading technology have made online investing simple for virtually anyone who wants to try it. That’s why there are 7.5 million online brokerage accounts today--a figure expected to grow to 18 million by 2002, according to Gomez Advisors Inc.

Most of these investors, however, aren’t hyperactive--certainly not by day traders’ standards. If you don’t have an online account, you probably know someone who does, or who is playing the trading game with a standard brokerage account. Odds are, that person isn’teating and sleeping this stuff. They’re just rolling the dice periodically.

So you buy a stock on Friday and you sell it the following Wednesday, because it went up, or down, 15%. You pay $20 in commissions, total. It was easy to buy and easy to sell. Maybe you learned something, maybe you didn’t.

Maybe, before you could trade like this, you merely bought and held mutual funds, just as Warren Buffett and Peter Lynch and John Bogle have advised you to do.

Is it wrong for you to be trying your hand at trading as well? “Most people who try to trade will fail miserably at it,” those ubiquitous Wall Street “experts” will argue. Many of them know from experience.

Fair enough. But some percentage of people do trade well, for whatever reason. And many of them may not yet know who they are. But they’re probably going to find out in the years ahead, as more Americans take a slice of their nest eggs and try their luck at picking stocks on their own, purely for short-term profit.

What we’re really talking about here is speculation, not investment, of course.

Buy-and-hold investors have been taught to reject speculation as inherently bad--evil, even.

But a nearly 70-year-old book on this subject has another view.

“The Art of Speculation” was written by Philip L. Carret in 1930. It has become a classic, and was re-released last year by publisher John Wiley & Sons. Carret died last year at the age of 101.

A legend on Wall Street, Carret founded the Pioneer mutual fund in 1928 and became one of Wall Street’s best-known “value” investors.

A value investor who speculates? To Carret, there was no contradiction. His image of the speculator was someone who does his homework, discovers investments that the market has misjudged, and ascribes proper value to them.

Here’s how Carret puts it in the book: “Has a new industry arisen, filling a new demand, adding new wealth to society, requiring new capital in generous volume? The alert speculator discovers it, buys its securities, advertises its prosperity to the investing public [and] provides it with a new credit base.”

Hmmmm. Sounds eerily like the Internet and the role of small investors with Internet-related stocks, doesn’t it?

OK, Carret probably didn’t have day traders in mind when he wrote the above. But he did make for a time-horizon allowance. It helps to be patient if you’re going to speculate, he said, but patience is a relative term. “A security may be undervalued, but if it is also out of style it is of little interest to the speculator,” he conceded.

To put it another way, a speculator looks for securities that he or she believes should be going up in price, and soon. A fast profit is the idea--not a lifelong commitment. Trigger-happy Wall Street pros have owned this game for years. That the small investor, now in possession of the necessary tools, should take a shot at it hardly seems surprising, or disturbing.

But how can the small trader know something about a stock that Wall Street pros do not? The wealth of market information available to average investors today makes that a more realistic prospect than ever before. For many people, however, it may just come down to instinct, or gut feel.

But then, how many “investment” decisions really are made with much more than that?

If it’s mostly instinct, one wonders how much help someone else’s advice can be to a trader. Still, Carret put forth some guidelines for speculators that still sound relevant 70 years later.

Here are a few of them:

* “Reference has been made to the timidity of the average trader in the face of a profit, his stubbornness when faced with a loss.” In other words, better to let your profits run, and cut your losses short, before the latter seriously destroy your capital.

* “The regularity with which a long-sustained movement in one direction has been followed by a long-sustained movement in the reverse direction is striking.” Carret was speaking broadly of market trends here, but he might as well have been talking about many individual stocks as well. As another sage once said, “There is no such thing as a growth stock--just companies in growth phases.”

(Many veteran investors can identify plenty of fading stocks they should have treated as trades, or speculations, at some point, instead of continuing to regard them as buy-and-hold investments that were sure to revive. Sometimes what’s down doesn’t come back up--ever.)

* “The speculator interested in a mine in the development stage is prone to underestimate the time necessary to bring it to profitable production.” Another point apropos to Internet-stock investing.

* Put and call options “are a mysterious subject to the ordinary speculator in spite of the fact that they afford one of the best possible media of gambling on a shoestring with any chance of success.” Great advice, maybe even more so today than 70 years ago. Options can be excellent tools for speculation or for hedging a stock portfolio against losses.

* “The fact that the average trader abuses credit is no argument against the use of credit in stock market speculation. For the trader who borrows in moderation, credit is a very useful tool.” Carret was talking about margin credit, or the ability to buy stock partly with borrowed money, to increase the potential payoff--while also increasing the risk of great loss. Margin use arguably is suitable only for traders who’ve been at the game for a while.

* “Applied to individual stocks, price-to-earnings ratios in themselves mean nothing.” The point being, you can’t look at P/Es in a vacuum. Cheap stocks can get much cheaper if there’s no catalyst for turning their prospects around. And expensive stocks often get more so, if the fundamentals are favorable.

Finally, Carret pinpointed one essential trait that drives many individuals who join the trading game. “The average trader is naturally a chronic bull,” he said. “It is human nature to prefer optimism to pessimism.”

Thank goodness for that.

Tom Petruno can be reached by e-mail at tom.petruno@latimes.com.