Yet another investing book that came out at precisely the wrong time. Precisely! But it might be useful now.
Bear Market Investment Strategies was published in 1981, a bare year and change before the greatest of all bull markets, 1983-2000, during which the DJIA increased some 13 times. In other words, this book helped you navigate the stock market environment that just ended, not the one that was coming.
There are a variety of reasons investing books come out at exactly the wrong time. It takes years for an investing strategy to prove itself, and once that happens, it takes even more time to write a book, find a publisher, design it, print it, etc. By the time a book finds you, it is more likely to tell you what not to do, not what to do. (If you're curious about this appalling phenomenon in investment book publishing, take a look at this video on my investing channel.)
Now, this doesn't make this book entirely useless. In fact, as I've explained elsewhere in this blog (in a review of another investing book published at precisely the wrong time), books like this can be incredibly useful if read outside of their era. To see what I mean, have a look at this quote, stating author Harry Schultz's central theme:
"Because of monetary chaos, rampant inflation, deficit spending, and government intervention in markets and economies, one can no longer find stable markets nor use 1950s methods. Today we must be a good deal more flexible."
Tell me: does this seem to rhyme at all with the current era? Eerie, isn't it? Thus perhaps we have the kind of book that might give a modern reader a decent game plan for handling this investing environment. Of course we won't know until later, but I think there's a good shot that it will.
On to some criticisms, as this book is uneven in places. The last third of the book feels phoned in, with chapters that read like partially finished blog posts and listicles. The level of sophistication expected of the reader isn't consistent: some topics are laid out for the general reader, while other highly advanced investing topics (like nuances of futures and options trading to choose an obvious example) are discussed without context at levels far too advanced for the general reader. Finally there's a surfeit of on the one hand/on the other hand-type predictions late in the book that are useless, including this howler: "I can only say that such a depression is highly possible, whether or not it is likely."
Finally, the author should have included a bibliography. He cites various important stock market authors throughout the text, but almost never cites their specific works. This leaves the reader dependent on their own Google-fu to figure out which books are worth exploring next. Never fear! I created an ersatz bibliography at the bottom of this post for anyone interested in what turns out to be quite a decent investment reading list.
Once again: never read any recently published investment book, except for contrarian reasons. Instead, seek out books from prior eras, and build yourself a mental library of context for how to deal with a broad range of investment environments.
Notes:
Preface:
ix: "Man is escapist. His primitive fight or flight mechanism instinctively urges him to flee if at all possible. In the modern world, he tends to do this on a mental rather than a physical level." [Useful insight here: People will do things to reduce discomfort, often at the expense of their capital! The market's crashing and you sell just to end the pain of loss, but of course this usually ends up being a poor decision as you tend to sell at the bottom, at the point of maximum pain.]
x: In the modern era there's no escape real way to really bypass the economic system, "you must learn to profit from the system itself." You're in an inflationary environment, or you're in an economic downturn, you need to figure out what investments will and won't work in those environments and adapt.
x: "...in a real depression, particularly of the inflationary variety, the only way to keep fairly liquid and at the same time be investing with the trend is to go short."
Section I: The Bear Background
Chapter 1: Definitions, Guidelines, and Term Limitations
3: Contrasting today [meaning the 1970s] from the 1950s and 1960s, "where it was only necessary to put your assets into blue chips and watch them appreciate year after year."
4: "Inflation... shortens the view not only of the stock market trader but the businessman as well." On the market being flat for more than a decade, crushing you if you held on because of inflation and currency depreciation; but if you had traded the moves along the way [here he cites the 45% decline in the Dow from 1973-75 and the 25% decline from 1976-78] "you would have done much better." [Of course if it were all so easy...]
5: "Be not a bull, nor a bear, but a realist"
6ff: Defending short selling, arguing it's not unpatriotic, citing Joe Kennedy, note also his hilariously fallacious justification on page 7: "If there was anything unethical, immoral, or un-American about it, the Securities and Exchange Commission wouldn't allow it." Tell that to Bernie Madoff's clients, or better yet, tell it to US pharma regulators!!
9: On the usefulness of downturns: "Humans don't seem to be able to cope with prosperity--as individuals or as a nation--so the cutting-down-to-size process comes along to force a return to more important values again."
9: On false prophets during depressions, recessions and bear markets; politicians that won't reveal the weakness in the economy; see also pundits who foresee great prosperity coming, etc. [It's reminiscent of how the US government basically redefined away the recession that happened in 2022 so there therefore was no recession.]
10: On thinking "contra" and using automatic skepticism; doubt as a device to preserve your capital. Politicians or business leaders may or may not be right, but most of the time they're wrong and you want to think contrarian in general.
12ff: Interesting quote here from Charles Dow from back in 1900, talking about action and reaction, and how a swing in a stock or the market tends to be followed by a relapse about half the size of the prior move. "It often rallies or relapses more than half of the original swing, but it is generally safe to wait for about half." The author deduces from this to watch the contra-swing, in a rising market, then, if that swing sits above the 50%/halfway level odds are that the highs will again be approached or beaten, if there's a major advance and the contrast swing goes below this half/50% level then the primary direction is bearish and downward and the lows will be approached or beaten. [You definitely see fractals of this type of action/reaction in many fields, not just in the stock market.]
13: "One must act contrary to the majority view--at the proper time and in the proper way."
Chapter 2: The Bear Market, History
17ff: The author gives a useful historical rundown of bear markets, their decline and duration:
1900: DJIA down 31.8%, 12 months duration
1903 down 37.7%, 10 months
1907 down 45.0%, 10 months, two phases, panic of 1907
1909 down 26.2%, 8 months
1912 down 23.5%, duration 26 months (December 1914 was the low and the stock market was closed for 4 months in 1914 so there's no true picture of the decline here)
1917 down 40.1% duration 13 months
1919 down 46.6% duration 21 months (note also a one-year depression began in the fall of 1920)
1923 down 18.6% duration 7 months
1926 down 16.6% duration 2 months, these last two were baby bear markets
1929 down 90.0% duration 34 months, six successive crashes into 1932 followed by a new bull market almost immediately
1934 down 24.1% duration 9 months
1937 down 51.8% duration 56 months, with five crash phases running up until April 1942, note also the 1941-42 period was the longest bear market non-stop downswing in history, 7 1/2 months.
1946 down 24.6% duration 37 months, followed by the great bull market in 1949 to 1961, where the Dow went from 160 to 741, "its most speculative orgy of the century."
1953 down 13.9% duration 9 months
1957 down 20.3% duration 6 months
1960 down 18% duration 10 months
1962 down 29% duration 6 months
1966 down 26.6%, 8 months
1968 down 36.9% over 17 months, "the first of the new-era bear markets"
1973 "a whopper!" Down 46.6% over 23 months, this was due to the oil crisis
1977 down 26.4%, duration 14 months, nothing dramatic caused it, just the same problems from earlier in the decade
22: Thus we have 21 bear markets across 79 years, meaning a bear market every 3-4 years on average, "The longest time span between bear markets was six years." The author's message here is "Bear markets are frequent enough to make it impossible to avoid them or to avoid their losses. Thus, the investor must try to understand bear markets better. Otherwise, the profits from the previous bull market are usually wiped out."
22: "The average investor is pitifully enough equipped for bull market gyrations and virtually a babe in the woods in bear markets. He seems willing to stay that way because of the strange notion that bear markets are rare, minor, and/or impossible to understand anyway." [As much as most investors--including me!--don't want to hear this and feel condescended to when hearing this, the first step towards becoming a better investor is to be able to swallow things like this and use it as fuel keep learning.]
23: Also note that non-blue chip stocks (here he's talking about names that aren't in the DJIA) can easily fall twice as much as names in the index. "...historically most stocks lose half their value in the average bear market." [Note also there is no such thing as an "average" in domains like this!]
23: Bear market durations range from as short as two months to as long as five years. A lot of bear markets are very short in duration, but note that we spent over one third of the 20h century (!) in bear markets, this indicates how dangerous the stock market can be. Also: "...by the time [investors] recognize a bull market is present, it is half gone."
24-5: Comments on the recovery period after a bear market: 1929 required 26 years (!) to recover to its previous high; 14 years required after the 1937 crash; two other bear markets required nine years to get back to prior highs; most others had drawdowns of one to six years. Also worth noting the average time between the initial crash and the final bear market low averages around 11-12 months with a range of 5 to 35 months.
25-6: Interesting comments (although the author doesn't phrase it this way) about the arrow of history looked at from retrospect versus looked at from market/media reports at the time: the 1929 crash had very few prior bear markets to compare to for people in those days, people were oblivious to how serious it ultimately would be. And yet note that "Between 1854 and 1933 the United States suffered precisely 21 depressions."
26: On the notion of playing both sides of the roulette wheel, black and red, going long or short "as circumstances warrant." [Obviously the idea here is to gain more tools to make you a better all-weather investor, so you can function in more market environments.]
Section II: Economic Setting for Bear Markets
27: Great example of the author's "contra thinking" right here, see photo:
"The story has long been told of a steel magnate who looked out of his office window at the rows of smoking factory chimneys, contemplated the healthy pile of unfilled orders on his desk, sent a memorandum to his production assistant to hire a hundred more men, and called his stockbroker to sell all the stocks he owned. "Are you crazy or something?" asked the broker. "No," came the reply. "In all my years the future for our business has never looked as good as it does right now. Therefore I must assume that from now on it can only look worse."
Chapter 3: Milestones, Guideposts of the Times
29: On distortions in the cycles due to regulations, government interference, other factors, etc., with the result that business cycles "ain't what they used to be."
30ff: Signs that a bull market is ending:
* Commodity prices move up sharply, this is an "essential" clue according to the author
* Stock price overvaluation: the author here uses yield to define/describe overvaluation, at yields under 3% is things are getting overpriced and if they hit 2.5% to even 2%, "the more certain you can feel that there's a bear around the corner." [This is one of those cues that may be less useful in today's markets, but it's still probably worth paying attention to the yield of the S&P500 with these numbers in mind]
* Strikes in the labor market
* High industrial production (note the stock market sells off well before the business sector reflects worsening conditions)
* Labor shortages
* Credit overexpansion (you can see this with too many IPOs for example)
* Splits and secondaries (secondaries can also reflect dumping by experienced investors)
* Public interest: the public is participating heavily in the market and the market is on the front page
* An abundance of confidence
* Inventories are high (obviously this indicator is for a past era, not for today when the world is increasingly full of inventoryless internet companies!)
* The real estate market gets hot and people speculate in it
* Churning in the stock market, volume is high but prices stay the same
* Unanimity of bullish forecasts
34ff: Signs that a bear market is drawing to a close:
* Bad news is abundant
* Very few strikes
* Stock market volume is low and at low valuations
* Confidence is low
* Commodity prices are low [note here the author doesn't discuss at all how commodity cycles have a completely different and much longer periodicity than stock market cycles]
* Government bond prices become popular and yields are low (bond prices are high)
35: Bear phases: the author quotes Robert Rhea here (author of The Dow Theory): "Bear markets seem to be divided into three phases: the first being the abandonment of hopes upon which the final operation of the proceeding bull market was predicated; the second being the reflection of the decreased earning power and reduction of dividends; and the third representing distressed liquidation of securities which must be sold to meet living expenses. Each of these phases seems to be divided by a secondary reaction which is often erroneously assumed to be the beginning of a bull market."
36: More discussion here of inventory running low, on orders and shipment of goods; a lot of this stuff is less applicable today to the kinds of companies that dominate today's stock market; today's market certainly has industrial stocks, but increasingly "virtual" companies tend to dominate stock markets today.
37: On watching your emotions: warning the reader not to let your own feelings or prejudices at the moment cause you to misread the situation, or expect too many "signs" (see notes to page 30-34 above) to tell you what's going to happen. If you're prepared and have awareness of all of the potential bull market/bear market signs above, then when you read or hear a fact of the changing economy you'll be able to interpret it immediately, "you know what to look for and you recognize it for what it is."
38: "The market always does what it should but not when it should." [Great, great quote]
Chapter 4: Fads and Foreign Investment
41-2: On noticing the difference between new concepts and new ideas and fads; fads are indicators of a bear market; they increase towards the end of bull markets. See investment trusts or the Florida land craze, both in the 1920s. [Pre-GFC we might cite homes bought with ARMs, two years ago maybe we might cite SPACs or PE-funded names]
44-5: Comments here on the interconnectedness of the economy and world stock markets; a house of cards, it all falls down together, pockets of prosperity are rare. Good to remember.
Section III: Technical Structure of Bear Markets
Chapter 5: Secondary Reactions
49: "Every leg down in a bear market is interrupted by a secondary reaction, which may come in two or three phases or little legs." A "reaction" would be an up move in a bearish market; these secondary reactions can give people a chance to get out, or go short.
50ff: Secondary reactions/contra moves as a perplexing phenomenon; in a bear market this would be an upward move against the prevailing primary downward trend; this corrects a primary market movement that went too far in one direction, it also dampens any speculative activity of traders following this trend; these movements tend to be more violent than the primary trend (for example a three week bear market rally could retrace 30-60% of the primary trend); these bounces spring from no visible base or area of support; they have a "turn on a dime appearance" because the market is short-term oversold.
53: On "dullness" in markets: in a bull market trend, dullness is followed by advances, hence the phrase "never sell a dull market"; in bear markets dullness is followed by more declines.
54: Long-term investors can ignore the secondary reactions; however, the author thinks it's worth trying to catch them because some reactions can retrace as much as two-thirds of the prior move.
55: On the psychology of these reactions: bullish investors think any price is a bargain if it's lower, also anybody who is short will cover, so you can get quite a bit of bullish short-term activity at times in bear markets; also anyone who bought at lower prices before the reaction has seen nice gains, thus they may want to book them; further, short sellers may "reload"; these latter factors bring the reaction rally to an end.
56: Debates about average size of a reaction: the general rule is 1/3 to 2/3 of the ground lost, but the range can really be as little as 10% or as much as 99.9%. [Again, there is no such thing as an average return! This part of the analysis sounds so fat-tailed and so non-gaussian that it's probably worthless to think too much about it]
57: Amusing here to see the comments on odd lot buying, this used to be a big deal but now it's utterly irrelevant to today's low- or no-commission investment world.
Chapter 6: Bear Legs Helpful for Getting Your Bearings
59ff: On "legs" or phases of bear markets; they tend to be compressed and more dramatic than phases of bull markets. "Legs" have less volume than the actual panic declines or crashes; different bear markets have different numbers of legs: typically it's three but the 1929 bear market had eight; they're just a way of keeping track of the perspective: whenever there's a market move in a new direction, and that move grinds to a halt and you hear talk that the primary move "is over" you can just assume there's going to be another "leg" in that same direction. The point here is that markets have waves [we could also call them fractals]; see also Elliott Wave theory.
63: "Because nothing is certain in the market, you must always assume it's possible for a reversal to take place."
63: "...somehow people in the market find it hard to turn their thinking upside down to apply normal rules in reverse during bear markets."
Section IV: Tools and Gauges for Measuring Market Might
Chapter 7: Weapons for the Bear War
67ff: Interesting epistemic discussion here during a discussion of fundamental analysis versus technical analysis: the author argues that with fundamental analysis you never know whether you even have all the necessary facts [actually I would argue this is untrue: you always know that you do not have all of the necessary facts! Note that is a critical stage for investors to reach: if you can recognize how little you know and how little can be known, and can handle the discomfort of the fact that you're investing with maybe 20-30% of the necessary information--and you cannot have more--you have leveled up in epistemic sophistication as an investor]. Note also that technical (price, volume, charting, etc) information is much more ludic, it is much more visible: the index "tells you what it tells you" the stock chart tells you what it tells you, etc. the author says "You do know that what you know about a specific index reading is all there is to know. There is no more. You can be sure nothing has gotten by you." [This is quite fascinating: on one level he's right, the technical indicators are right there and observable, the numbers are the numbers. But on another level it's not right, because the system is recursive and everyone else is looking at those indicators and making their own inferences and decisions.]
68: Useful meta-insight on knowing your tools: "It's usually better to know a tool well--even though you may surmise it's not the best tool available--than to use a great many tools that time prevents you from getting to know like a brother. It's like an artist with an old brush. He knows there are better, newer brushes, but he knows what he can do with the old one." [The author then goes on to say, oddly, you want to use as many indicators as you can handle, in any case not less than 10.]
69ff: On creating your own personal index, a weighted vote of your various indicators and tools [this section has a lot of extreme "precisely wrong" precision that's unjustified here]
70ff: Here's a list of 18 basic tools:
* The advance-decline line ("this is surely the most basic and important tool of them all." and "Observe the way in which it diverges from the averages.")
*New highs/new lows (nuance here on using a moving average of up to 5 or even 10 days to smooth things)
* Odd lot balance index (divide daily odd lot purchases total into daily odd lots sales, if it's above 100%, it means the "little man" is selling more shares than he buys, "pros often sell when the little man suddenly buys or buy when the odd lotter suddenly sells")
* Odd lot trading ratio (add odd lot sales and buys together and divide by total market volume for the day, then cut the answer in half because market volume represents both sales and purchases; the result is a figure between 7-13%, normally it's 10%, it shows to what extent the public is in the market or the faddishness of the stock market; a low number is bullish)
* Odd lot short sales index (when "little people" are shorting on a big scale it is very bullish)
* Volume (there's some 25 different ways to measure volume but it's also incredibly important to measure and understand, per the author; note also the comments here from Joseph Granville about early selling happens on low volume as professionals take action, but then there's a selling climax when the public gets more and more frightened and starts dumping everything. Recognizing this climax is a sign for a technical rebound and professionals can now start buying)
* DJIA 30 week moving average: ("Generally the 30-week moving average stays above the current price in bear markets, below it in bull markets. It gives cues and clues when the price attempts to penetrate the moving average. If a penetration lasts for several weeks, it tends to be regarded as a valid signal.")
* Overbought-oversold index (there are many forms of this index, the most popular is a 10-day moving average of the difference between advances and declines)
* Confidence index: this is from Barron's, it's the ratio between the yield on high risk and low risk bonds and it "supposedly shows the thinking of the elite money minds" (the author is suspicious of this indicator)
* Short interest: all sales sold short need to be bought back someday; also pay attention to arbitrage positions which can skew this number: arbs may be put on that have nothing to do with being bearish; note also that arbs can easily amount to 5% or even 10% of the market's total short sales
* Short interest ratio: short interest divided by current average daily volume: if it's large (2% or higher) this is bullish because they are too many shorts for the amount of daily volume; when it's small (1% or below) it's bearish; this is an imperfect indicator per the author
* Brokers free credit balance index: this is a measure of money held in customer brokerage accounts, it indicates latent buying power. "It tells us, rather reliably, what stage of a bull or bear market we are in."
* Debit balances index (the Siamese twin of the above index): this is money owed to brokers in margin accounts, it represents shrewder traders, this indicator rises during the first two stages of bull markets and then drops steadily through the bear market following
* American Stock Exchange indexes: reflects some more speculative aspects of Wall Street, "Blue chips alone never made a market." Also watch for disparity between the AMEX and the NYSE, the AMEX has to go along with the New York Stock Exchange or "it's no show" per the author; also the AMEX tends to top out and go into a decline before the NYSE, thus giving an important preview
* Resistance index: if the market is up, subtract the total issues advancing from the issues traded, then divide the figure by the issues traded total, if the market is down do the same thing using declines; this percentage represents "resistance" to whatever the market is doing. Resistance levels of 30-60% are typical and when it leaps or falls to touch either of these extremes it is "showing resistance"
* Leadership index: the average price of daily volume leaders, this is the indicator of the leadership of the stock market and if it falls on upswings or rises on downswings this is bearish
* Percent of advances index: divide the daily advances by the issues traded. This is another way of approaching the overbought-oversold problem
* Gold shares index: if shares of gold-related companies rise with the Dow Jones Industrials this is bearish; this index is not as reliable as it was in the 1950s 60s pre-currency crises
81ff: The author here gives a list of his "personal original indices" including: DJIA 10-day moving average of internal volume, DJIA resistance, DJIA volume ratio (measures the volume of blue chips as a percent of the market total volume), advance-decline 200-day line, American Stock Exchange volume leaders, foreign stocks etc, many of these things are not applicable in this era, some 40 years later.
82-3: On the interconnectedness of global business climate, the business world and the stock market, whether Iran explodes into violence or whether Saudi Arabia does something, etc., many of these things really rhyme with today. See also this quote: "There was a time when life was simple. The New York market seemed as though it would climb forever. The dollar was sound, beyond reproach, and convertible into gold. The United States was the undisputed ruler of the free world. The times have changed." [Holy cow have they ever.]
84: On the dividend yield of the Dow Jones Industrial Average at bear market bottoms and other turning points: "It is one of our safest, if not best, indicators." At the 1929 peak the Dow average yield was 3.3%, at the crash low two months later the yield was 5.2%, yet that yield ultimately went to 10.3%. [Note also, I have successfully used a dividend yield heuristic for industrial and materials stocks: if they ever get to a yield of more than 4% and the company has the balance sheet and the cash flow characteristics to maintain that dividend, then it's a good time to get started buying. I think you can also use this heuristic for mature technology companies like Taiwan Semiconductor, Analog Devices, etc.]
87: Good insight here on waiting for a high-percentage play: the author here talks about having your various indicators heavily weighted in your favor; the idea here is to wait to really put money into a stock or sector if there is significant significant upside that you think is highly, highly probable; all of this is just a way of rephrasing Buffett's saying about "waiting for the fat pitch."
88: Interesting blurb here where the author talks about how the DJIA is less important compared to other indexes and then goes on to say how in the late 1970s a lot of over-the-counter stocks were up a lot while the Dow was moving sideways, "thus distorting the picture of great opportunity that existed in a large area of shares--but that got almost no publicity." Interesting nuance there on the late 70s.
96: Note the photo below of a list of names from American Stock Exchange in this book's day:
It is horrifying how few of these names not only no longer exist, but worse, that no one has ever heard of most of these companies. The takeaway here is to understand how cruel creative destruction and market competition can be, and how so few companies actually make it long-term. This image ought to sit in the back of every investor's mind!
Chapter 8: Tools That "Change Shape" in Bear Markets
103: Some indicators have to be looked at differently in different environments: see for example the overbought-oversold index, which can go all over the place during bear markets without meaning much (and it will thus mislead you into thinking a market turn is coming). See also the short interest indicators which indicate support under the market in bull markets, but may not indicate anything in bear markets because the short positions might remain in place for years (some people put on shorts and have no urgency to cover). As a result "many an amateur can be misled into buying when short interest climbs to its first new high in a bear market."
105: The author's point here is not to point out every single nuance with every indicator, but rather to get readers to recognize that there are no fixed rules here: you have to be flexible with different indicators in different environments.
106: "History shows that bear markets tend to last a third to half as long as their preceding bull market." [Note that this most certainly did not hold true for the 2000 tech crash (3-ish years) after the 1983-2000 bull market (17 years), and it didn't hold true even across the various fractal mini-bear markets that happened during that period either, like the very brief 1987 crash or the 1989-1991 recession.]
Chapter 9: The Validity of Cycles
109ff: "Numerous economists and others have looked back in retrospect, found an apparently recurring historical pattern, and projected it forward. It has seldom worked." See Kondratiev and his Cycle Theory for example, which was not predictive in 1970 despite a supposed 50-year cycle. "Life is not a mathematically recurring phenomenon but a dynamic ongoing process... it is very difficult to equate past errors exactly with our own." See also technological revolutions: the author cites the computer as a key example but also cars versus horses or hand farming wheat versus scaled and mechanized farming; thus cycles with these types of huge innovations can't be compared... I am simply saying that the use of the past as a projection for the future can only be done in a very loose sense and that we can never expect an exact duplication of a past event the second time around, which is the principle of true cycles study."
112: Another interesting example of the complete lack of parallels between eras: the United States has 15% of its population working for the government, and if you add unemployment figures to that we have non-cyclical employment running at about 20%. Recall that when unemployment hit 20% in the 1930s there was a depression! The government wasn't providing welfare and the economy collapsed. Yet currently we have a relatively prosperous country and 20% of the population is not producing (technically speaking) and is supported by the rest. The author's point here is how technological innovation of the private sector enables tremendous support of the public sector.
113: On parallels that can be drawn from one era to the next, they can't be superimposed blindly, but human reactions tend to be similar in similar circumstances. The issue with cycle research is that it tends to apply the cycles too exactly, too precisely.
Chapter 10: Chart Interpretation
A review here of Dow Theory: whenever the DJIA moves to a new rally high or low the Dow Jones Transportation Average must do the same shortly thereafter, thus confirming the move, or else the move is false and cannot be sustained and a reverse will follow. Also vice versa if the transports make the first move. [This is also less applicable in today's tech-heavy Magnificent 7/FAANG market.]
120ff: On charting: recommending Robert D. Edwards and John Magee's book: Technical Analysis of Stock Trends. "People patterns are what you really see on a chart, not the stock alone. [It's kind of wild to think back in those days these dudes would make these charts by hand!]
122ff: Amusingly abstruse discussion here on whether to use arithmetical graph paper or semi-logarithmic graph paper; the author thinks that people think in terms of "Dow points" rather than percentages and so if the Dow moves 10 points it has the same feel whether it's from 800 to 810 or 900 to 910 although technically the move percentage-wise is greater at the lower level. [I wonder how he would think about this for the Dow is at 38,000 today... you can't even feel a 10 (or even a 100) point move with 38,000 as the denominator]
Section V: Money-Making Tactics
Chapter 11: Preservation of Capital in the Stock Market
127: On the idea of preserving capital during deflationary times, this is when cash "increases" in value [for the pedants out there, yes, cash doesn't literally increase in value, but if you think of all assets in relative terms, cash "increases" in value relative to assets that are deflating, and now you can buy such assets for less cash]
128: The author recommends using stop loss orders for reducing your equity holdings in the late stages of a bull market: the stop loss should be set 1-3 points below the current price in accordance with its short-term uptrend line; note also the comments on emotional thinking here: on issues like what if the stock market has already entered a bear market, what if it is too late to sell, etc. [NOTE: please see my commentary on the note for page 148, below, to address a little known risk of stop loss orders.]
129: "The top of a secondary reaction (up) in most bear markets offers the highest prices that will be seen for probably 1 to 5 years... So, the prices on this reaction will be the best you can hope for even though they may look pitifully low to you, since they had been so much higher six months before." [This is very difficult to handle for even advanced investors, it's incredibly painful to sell when prices were so much higher so recently. I solve for this by thinking in multiyear or even decade long time horizons: if I can't see holding a stock for several years, and holding it through anything that comes, I shouldn't buy it in the first place, and further I probably need to have higher cash balances to offset any psychological stresses a bear market might impose on me.]
129: [It's fascinating to see the mentality of someone who just survived the 1970s era trifecta of high inflation, a terrible stock market and high interest rates, and compare to a modern investor who "knows" that the stock market "always goes up in the long run." The level of terror implicit in the former mentality is interesting and the lack of terror in the latter is likewise interesting!]
129ff: [Worth noting that this chapter has a lot of minutiae-based thoughts on "getting out when the getting is good" when you as a reader may simply not invest this way. For my part I think in terms of multi-year or even multi-decade holding periods for a lot of my investments, and I doubt I'm going to be successfully able to be cute and get out of the way of some correction, or a "second leg of" a correction, or whatever. One has to know oneself.]
138: The section here on traveling abroad and continuing to invest is kind of hilarious: back then of course the author had to make an expensive phone call to New York, or find a local broker to make that call and put in a transaction; today you just log on to your broker's website wherever you happen to be. Sometimes modernity isn't all that bad after all.
Chapter 12: The Tactics of Short Selling
141ff : Any reader reading this chapter should carefully read Mohnish Pabrai's comments on short selling to balance out Schultz's view; Schultz author of course talks about some of the catastrophic risks of shorting: how you can buy a stock at 12 and it can only go to zero but a stock that you short at 12 can go to 50 or 400, etc. This is true and good advice, but then Schultz says "but in practice it doesn't, assuming you are in a bear market." (!!)
143: "Esau, in the bible, sold his inheritance short, one he did not own, to his brother for a meal of potage." Other intriguing examples of "short selling" in one form or another, like a lawyer selling his services "short" when accepting a retainer fee, or the post office essentially selling short when you buy a stamp. Interesting.
144: "I believe short sales should always be protected with a stop loss order [the author suggests the 10% loss limit]... No nightmares, no big risks." [Again, see my notes under page 148, below]
145ff: On selecting good short candidates:
1) The stock must have had a large rise in recent months, preferably an emotional one "not founded on factory reality."
2) "The rise was on increased volume implying that many people will rush to protect their paper profits when the stock starts breaking down."
3) "It must have stopped rising at least three weeks ago, preferably longer."
4) It must show large volume at the top but is unable to rise higher, and most recently has started breaking down
5) It has not declined more than 10% from its secondary peak
6) Must have an abnormally high price earnings ratio
7) Must have a low short interest
8) Here he doesn't quite say it right, but he wants you to avoid stocks with thin floats or small market caps
Then, from your list of stocks, choose those with the greatest downside volatility, in industries "on the downgrade" [whatever that means] and that have just created a bearish chart pattern like a double top or head and shoulders, are very popular and widely traded.
147: On watching your short positions' relative strength: does it rally less on upswings compared to other stocks? Short or sell stocks that are weaker than the market gauged by relative strength.
147ff: Note that the math of shorting is not as attractive as being long but typically sell-offs happen very quickly so your profitability measured in time can be much greater. "Fortunes can be amassed in days or even hours in a disintegrating market." Besides examples of panic phases of bear markets where the market can drop 15-25% in a matter of days, note that when the market index drops this much it means many stocks are dropping 40% or even 60%. [This is a good point, but often the panic phase happens so fast that you can never really catch it.]
147-8: Inverting the "never sell a dull market" expression during bull markets to "always sell a dull market" during a bear market. Again, interesting to think in inversions based on what kind of market backdrop you're in.
148ff" "Rallies in bear markets are traditionally sharp." [Ah, so you can lose your fortune after all! NOTE: It's also worth noting an important point here on stop loss orders, which is when a stock triggers your stop loss, it then becomes a market order. This doesn't always mean you will get filled at your stop-loss/buy-stop level! What technically happens is your stop-loss gets triggered and then your stop-loss order becomes a market order, done at whatever price the system gets for you. This is usually not a problem, and you typically will get filled at your stop loss price or close. However, during really volatile, fast-market conditions a stock may blast right through your stop-loss levels and then get sold (or bought if you're short and covering) at much worse prices. You might think you have protection because you have a stop loss in place but it doesn't mean you'll get filled at that level, not at all. The fact that the author doesn't discuss this nuance at all is disturbing. And that's not all, see note for page 173 below for yet another catastrophic risk of stop loss orders.]
150: On paying the dividend, the author says there's "no need for concern because the stock usually drops in price to allow for the dividend, so it has no real effect." Note also the free credit balance (from your short sale proceeds) which you can earn interest on, or potentially use to purchase other stocks if you have a margin account.
151ff: A repeat here dealing with the objection that shorting is somehow unpatriotic, here referring to Napoleon making the unpatriotic claim himself. "But Gaudin [Napoleon's finance minister] explained to Napoleon that those who did so were 'expressing their judgment of future events,' and 'not their wish' for the country." Also addressing instances where short selling was ruled illegal [this actually happened during the 2008 GFC], usually the market crashes even more when this happens! It sounds counterintuitive but the short sellers actually provide buying power when no one else wants to buy.
152: On the ire people have for the successful bear.
153: "And remember, solvent citizens are of more use to the nation than insolvent ones."
Chapter 13: The Essence of Making Money
157: This quote made me laugh. "This section is probably the sweetest nectar in this volume, for it is an attempt to crystallize the key ingredients of making money in the market in a single, simple technique that is as near foolproof as any approach I know." [Unfortunately this chapter is rather disappointing: there's very little nectar here.]
159ff: The central idea here is to keep a (buy) stop loss order on your short position (and you have to adjust it daily!) that you let drift down as the stock declines, and so you will always be sure to lock in a profit. [Can't say I agree with this, just for the mental bandwidth reasons alone. His point here, though, is to never cover the short, just allow yourself to be stopped out if that's what happens.]
162: Rules/tactics here on short interest, if a stock has a short interest of 20% or more this is way too high to put on a short, low- to mid-single digits (which would be seen as a negligible short interest ratio) would be more appropriate; the author also goes over basically what is a "days to cover" ratio: the number of shares short divided by average daily volume. If it's something like five days to cover that's incredibly bullish and thus a terrible short; you want the short interest to be a fraction of daily or weekly volume.
164: On the trap of being more interested in being right than making money/cutting losses. [This is a critical insight, and the author should have gone much deeper into this concept! A lot of ludic/"good student"-type people struggle with the stock market in part because they struggle with all the opinion reversal that's required--the problem is the market is recursive and often makes you wrong even when you're right (for example, you were right on a thesis but the stock already went up more than enough to account for it, so you actually want to take the other side of the trade instead). Thus you must lose your attachment to wanting to be right, or as the author phrases it "you must have no pride of opinion"] "You must have no pride of opinion... and not hesitate a second to admit you made a mistake and reverse your direction from forward to back or back to forward."
164: A quick summary: select a high-volume stock with a sharp trendline, stick to one stock, stay in it until stopped out, place the new stop losses daily based on a trend line, trade short or long depending on the trend, if in doubt stay out, check the short interest, forget pride of opinion, buy in round lots.
Chapter 14: Rules for Being a Flexible Investor and/or Trader
167: [It's amazing how much history rhymes: this quote where the author describes the stock market of his era sounds exactly like today's era] "Because of monetary chaos, rampant inflation, deficit spending, and government intervention in markets and economies, one can no longer find stable markets nor use 1950s methods. Today we must be a good deal more flexible." [On being pliable, alert, willing to get out of things quickly, and generally aiming at shorter-term time horizons and capturing shorter term profits. Again, however, note that we were just about to enter one of the greatest buy and hold investment environments ever right after this book came out.]
167ff: [This chapter is full of horrible advice: like using margin, not investing long-term, that there's no good alternative to trading in and out of stocks. I get it, this is what you had to do to survive the 1970s, but there was about to be an extinction event for investors like this, and that's the real takeaway from this book.]
169ff: Here there's a superficial, actually dangerously superficial, discussion of hedging in commodity futures here; first of all you have to have a futures trading account (which is above the head of most investors), and the trade involves holding a longer-dated future, where you lay on a short position with a near month inside that longer-dated future for when the price goes against you.
173: Finally! We have an admission of yet another risk of stop-loss orders where the specialist keeps your stop level in a book, and thus the book of stop orders itself is what drives the price to trigger those stops; thus by having you stop loss in place you expose yourself to a fragility of publicly showing (for the specialist and other market makers) precisely where you'll be forced to buy or sell! The author should have discussed this already, and you could write an entire chapter of a book about this problem.
174: Discussion of straddles again here in the context of commodities or currencies. It's probably better to do this in the context of stock options around an existing underlying position.
176: On how it's bad if you make money on your first stock--it only teaches hubris. This is even more true for futures and options trading.
178: Again the author is touching on stuff here that's simply too sophisticated for the rest of this book, but nevertheless, here is a good point for people tinkering in commodity markets where you will want to learn to hedge positions in the London market for a US commodity if and when necessary. Sometimes commodity futures trade limit up or limit down for several days and thus they never give you a chance to get out of a position: this can destroy you, so you want to have the ability to hedge out the position in another marketplace.
Chapter 15: How to Avoid Recessions' Biggest Waves
179: "Every asset you have needs to be reevaluated in a bear market."
182: I have to confess the book is not holding much of my attention right now, it's kind of gone sideways. Frustrating for example to read a howler like this "prediction" where it's heads I win tails you lose: "a depression is highly possible, whether or not it is likely." This quote appears in a section talking about existential risks to the banking sector and concerns about a full-fledged 1929-caliber depression, things that absolutely did not even come close to happening in the decades after this book was published.
184: Another sad prediction here: "A really bad one [bear market] seems due. I think it will be soon, but if it is not the next one, then it might well be the one after that." [One can't help but think of Yogi Berra here: "predictions are difficult, especially about the future."]
Section VI: The Emotional Aspect
Chapter 16: human psychology in the marketplace
190: On how "our nature as optimists does us great damage in a bear market, which is our primary concern in this book."
191: On the need to have extraordinary courage. [This is actually an interesting paradox, something the author doesn't explore, but I can't seem to stop thinking about: somehow you have to temper your optimism, or even be deliberately pessimistic at times, but at the same time you have to have courage, which is a mental state that is similar to optimism on some level, the Venn diagrams overlap a little bit. This is worth some further thought I think: what kind of mental state do you really want to have to be a good investor in different kinds of market environments? Is it really courage, or is it really more like a carefully regulated fear?]
192: Extremely useful quote here from Gustav Le Bon in his book The Crowd (although once again the author does not cite the book and I had to find the source myself) "Whoever can supply the crowd with attractive emotional illusions may easily become their master, and whoever attempts to destroy such firmly entrenched illusions of the crowd is almost sure to be rejected."
195: On humility about our emotions: if you think you're objective you almost certainly are the opposite. This is just like epistemic humility: the people who think they have all the answers typically know very little, "those who know a great deal feel they know hardly anything." Dunning-Kruger, basically.
Chapter 17: The Crowd Is Usually Wrong
201: On the need to think in a contrary way, having a skeptical attitude, avoiding the crowd but not assuming the majority is wrong all the time. "They are likely only to be wrong when there appears to be no division of opinion. The logic of this is that life is an ever-changing thing; and opinion that begins by being quite sound dates itself like everything else so that, by the time everybody has come around to holding it, it should already be history, and a set of circumstances that originally caused it have changed." [Again, the central idea here is the fundamental recursiveness of markets. You have to know what people generally think so you can position yourself relative to that consensus.]
201: The author goes through an example of how a group of insiders take action on a stock and then others follow, and then soon enough everybody sees what's going on, and thus it's imputed into the stock price. "The art of applying contrary opinion to the market, therefore, is to gauge at what point the technical and fundamental reasons are so obvious that they can be seen by anybody. For that is the point in which the experts take their profits, and so should you. Although this theory is known as thinking contra, this is not strictly true. What one aims at is rather to think before the crowd, and this is usually synonymous with thinking contra."
206: "And contrary thinking is part of thinking, for it gives freedom to thought and loosens it from the chains of simple acceptance."
Section VII: Economics, Predictions, and Conclusions
Chapter 18: The Economic Picture in the '80s
[This is a terrible chapter sharing the author's economic and tax policy ideas, it has nothing to do with the book.]
212: Interesting blurb here about Calvin Coolidge in 1924 saying "not over 25%" was the optimum tax rate to maximize collections. [Heh, I guess the Laffer Curve was around a lot earlier than Art Laffer ever was.]
213ff: Rehash of the 20s and 30s leading up to and into the Depression, complaints about taxes, socialism, regulation, etc.
Chapter 19: Predictions
226: Note that this is a weird, borderline unreadable chapter that contains no predictions at all. However, there is one insight: don't make predictions! At least do not make them in front of others, so you end up defending them [or defending them egoically, as the author means here: having an emotional or reputational attachment to being "right" in your prediction]. The idea here is to set conditions (egoic or otherwise) to stay flexible, don't be stubborn, and reposition yourself as needed.
Chapter 20: Conclusions
228: "...the word "stagflation " was coined (by me)." ??[For what it's worth, Google doesn't agree, citing British politician Iain Macleod as the coiner]
To Read:
Robert Rhea: The Dow Theory
Humphrey Neill: The Art of Contrary Thinking
Humphrey Neill: Tape Reading and Market Tactics
Humphrey Neill: The Ruminator
William Peter Hamilton: The Stock Market Barometer
Jim Sibbet: How to Profit Three Times from Inflation (lecture)
H.M. Gartley: Profits in the Stock Market (per the author, "H. M. Gartley was a great technician in the 1930s. He did more work on volume than any other man.")
Richard Russell: Dow Theory Today
Robert D. Edwards and John Magee: Technical Analysis of Stock Trends
J. Edward Meeker: The Work Of The Stock Exchange
Edward E. Hooker: You Can't Win in Wall Street
Finally, the author chose quite a beautiful dedication quote for this book. Investors would understand perfectly.
