Chapter VIII



MECHANICS OF THE MARKET

IT has been shown that, for all practical purposes, manipulation has, and can have, no real effect in the main or primary movement of the stock market, as reflected in the averages. In a primary bull or bear market the actuating forces are above and beyond manipulation. But in the other movements of Dow's theory, a secondary reaction in a bull market or the corresponding secondary rally in a bear market, or in the third movement (the daily fluctuation) which goes on all the time, there is room for manipulation, but only in individual stocks, or in small groups, with a well-recognized leading issue. A raid upon the oil group, or upon the bear account in it, with special attention to Mexican Petroleum, may easily have a striking temporary effect. It shakes out some weak holders or it forces a few bears to cover, as the case may be. This sort of professional "scalping" is often in evidence in a secondary swing for good reasons.

The Trader and the Gambler

Every primary market, bull or bear, tends to overrun itself. As the traders say, there gets to be too much company on the bull side ; or conversely, the u loan crowd" shows that too many shorts are borrowing stocks. There is even a premium for lending them, corresponding to what is called a "backwardation" in London. This is the professional's chance. He buys in a market which is oversold or, with testing sales, he tries out the strength of a market which has been bought not wisely but too well. The small speculator, and more particularly the small gambler, suffers at the hands of the professional. He is a follower of "tips" and "hunches." He has made no real study of the things in which he trades. He takes his information without discrimination at second hand, lacking the ability to distinguish good from bad. He has no business in the market, in the first place, and it could get along very well without him. It is a great mistake to suppose that it is he, or people like him, who keep the Stock Exchange houses in business. Every one of these will tell you that their customers are becoming better informed all the time. Of course if ignorant people will sit in a game requiring expert knowledge, against others who understand the game perfectly, they can blame their losses on no one but themselves. They do, in fact, audibly blame Wall Street. A substantial part of the time of most brokers is consumed in protecting people from themselves. It is a thankless job. A fool and his money are soon parted.

Giving a Dog a Bad Name

But it must be obvious that this is no part of the main current of speculation. It bears about the same relation to that current that the daily fluctuation does to the primary market movement. There are, of course, varying degrees of knowledge, but it is a vital mistake to suppose that speculation in stocks (for the rise at least) is a sort of gamble in which no one can win unless there is an equivalent loss by somebody else. There need be no such loss in a bull market. The weak holders who are shaken out in the secondary reactions miss a part of their profits; and, in the culmination of such a movement, a great many people who have lost sight of values and are buying on possibilities only, with the latent hope that they may unload on somebody more covetous than themselves, are apt to get hurt.

So far as blaming Wall Street is concerned, it seems to have become a case of giving a dog a bad name and hanging him. The defaulting bank employee usually pleads something of the kind. All his transactions and contracts are matters of record; but how seldom the court asks him for an exact statement of his speculative account. He says nothing about fast women and slow horses, or the many other devious ways of spending other people's money. He pleads that he was "robbed in Wall Street," and sentimental people take him back to their hearts, registering horror at the temptations of the wicked financial district, whose simplest functions they have not been at the pains to understand.

A small and unsuccessful speculator, chagrined at his inability to make money in the stock market but failing to understand the real reason, picks up a vocabulary of technical phrases which is apt to delude people who know even less of the stock market than himself. He is fond of denouncing the "specialist" and the "floor trader." He classes them with the croupiers of a gambling house, and says that they are not even as respectable as that because their dealer's chance is extortionately larger. To take the floor trader first, it may be pointed out that his small but real advantage only stands him in good stead against the novice who is trying to snatch quick profits in an active market by the merest guessing. No competent broker encourages the outsider to do anything of the kind, and the brokers of my fairly exhaustive acquaintance in Wall Street do their best to get rid of a customer who is apt to be a liability rather than an asset, and is always a nuisance.

The Floor Trader and the Market Turn

There is no intention here to write a textbook on the practice of Wall Street and the Stock Exchange. There are excellent books covering that field. All that is necessary is to make sufficiently clear the mechanics of our barometer, and especially those things which may be assumed, rightly or wrongly, to influence it. It is sufficient to say, therefore, that a "floor trader" is necessarily a member of the Stock Exchange, and is usually a partner in a brokerage house. He unaffectedly operates for himself. He pays himself no commission, and he is at an advantage over the outside speculator in the matter of the market turn, which is, of course, the difference between the bid and asked price in the market. The more active the stock the closer this turn is, but it may be averaged at a quarter of one per cent. Assuming that the price of United States steel common is 90 1/4 bid and 90 1/2 asked, the customer who gives an order to sell cannot expect to get better than 90 1/4, while, if he wishes to buy, he must pay 90 1/2. The floor trader can often save this turn or part of it for himself not, of course, against a customer. He may be able to deal at 90 3/8 or even to sell at the asked price. Whatever he does has its effect in the daily fluctuation. In practice it means that the floor trader can afford to trade for a quick turn where the outsider cannot. In daily custom the trader goes home at the close with his book even, not hesitating to take an occasional loss, or glad to come out even.

"Bucketing"

It is obvious then that the floor trader, snatching a turn of a point or so, has an advantage. If the customer tried to do it he would have the broker's commissions of a legal eighth per cent each way against him, with the market turn of a quarter per cent; so that, as a mere gamble, he would be betting heavy odds on an even-money chance. A "bucket shop" would encourage him to do that, because the keeper of such an establishment works on the theory of new customers all the time, fleecing them as thoroughly as possible while he has the chance. None of his orders is really executed in the stock market; so that he himself pockets this extortionate dealer's chance. But we are considering the Stock Exchange itself, and its speculative market as a trade barometer. Bucketing is no part of the Stock Exchange's business, and the police can stop it elsewhere if they choose.

Old and Satisfied Customers

Commission both ways and the market turn do not amount to much if the customer is buying on values, with ample margin, or with the ability to pay for his stock outright, together with the tested belief that the stock he has bought bids fair to look attractive at much higher figures. He is the sort of customer the Stock Exchange houses strive to serve. A house which was in continuous business since 1870 has recently changed its name. It had at least one customer who had been on the books for fifty years, and many for twenty years and longer. This does not look as if the outsider always lost money in Wall Street, or as if the conditions of business made losses inevitable.

A brokerage house, like any other business, works to get new clients all the time, exactly as a paper or magazine works to get new subscribers. But the experienced broker will tell you that while advertising methods will bring the customers, nothing but disinterested service will keep them. I have often noticed that the really successful man in Wall Street is curiously inarticulate. Experience has taught him to keep his tongue between his teeth, and he is not at all communicative. The unsuccessful seem to be unable to keep their losses to themselves, in most cases, and it is usually found that they are thus articulate from a radical defect in character. They habitually do too much talking and too little thinking.

No Apology Offered or Required

This is not an apology for the stock market. Our old friend, our unwilling stepfather, George III, was not renowned for his wit. But when he was offered the dedication of Bishop Watson's celebrated Apology for the Bible he asked if the Bible needed an apology? Let us, therefore, content ourselves with merely explaining that part of the mechanism of the stock market which should be understood for a full comprehension of the nature and usefulness of the barometer of the country's business.

"Specialists" in particular stocks, corresponding in a way to the "jobber," or more nearly the "dealer" in the London Stock Exchange, the brokers on the floor who limit their transactions to one or two active issues and are entrusted with orders in those issues by other brokerage houses, are little understood and much vilified. It is falsely assumed that they habitually, or at least occasionally, abuse their confidential position. The specialist has "stop-loss" selling orders in a number of stocks at a point or so below the market price,
from brokers instructed to limit their customers' losses in the event of an unexpected decline. It is suggested that the specialist, for his own advantage, brings about that decline. The answer is that even the suspicion of such dealing would cost him his business and his reputation. It recently cost a member his seat on the Exchange, the only instance I recall. Transactions on the floor are by word of mouth, without the passage of a written contract or even the presence of witnesses. The honor of the parties is absolute, and I can hardly recall a case where it was called in question. There must necessarily be occasional misunderstandings, but these are referred for adjustment in the usual way. The specialist could not stay in business if he did not have the interests of the brokers who employ him as much at heart as any other agent in a like position. His very living and standing in business depend upon it.

Professional Trader's Limited Influence

What is the influence of the active bear trader on the averages? It is negligible so far as the major movement is concerned, a small factor in the secondary swings and mainly influential, at times, in particular stocks in the least considerable movement, the daily fluctuation. Such operations do not affect our barometer in any degree worth serious consideration. Remember the character of the twenty railroad stocks and the twenty industrials used in the two averages. Every one of them complies with the stringent listing requirements of the New York Stock Exchange. Each company concerned publishes the fullest possible figures of its operation, at frequent intervals. There are no "inside secrets," of market value, which could by any possibility affect more than a single stock out of forty.

It may be that one of them unexpectedly passes or increases its dividend. The effect upon that particular stock, if there is any real surprise in the matter (which is highly doubtful), is negligible when spread over the other nineteen stocks of the same group. I do not recall any useful illustrative instance; but suppose unexpected dividend action produced a fluctuation of ten points. It would only make a daily difference in the average of half a point, which would be almost instantly recovered if the dividend action presaged no broad general change in business conditions. If there had been any such change we may be entirely sure that it would have already been reflected in the stock market, which would know far more about it than that, or any board of directors.

Short Selling Necessary and Useful

A discussion on the morality of short selling would be utterly out of place here. It is true that the bear cannot profit except where another loses, while the bull at the worst reaps a profit which another man might perhaps have made if he had been attending strictly to his business. But every free market for anything is helped far more than hurt by traders willing to sell short. If, indeed, there were not this liberty the result would be a most dangerous market, liable to an unsupported panic break at any stage of its progress. Voltaire said that if there had not been a God it would have been necessary to invent one. It must have been long ago, in the days when what afterward became the London Stock Exchange did its business in Jordan's Coffee House off Cornhill, that bear selling was invented. It soon became a patent necessity; and it is curious that some of the most serious breaks in the London market have occurred, not in the wildly speculative securities, but in bank stocks, where the English law prohibits short selling. It was unsupported pressure in some bank stocks which helped to make the Baring crisis of 1890 so serious. There is no such valuable support for a falling market as the uncovered bear account. When it is absent, as in this particular instance, nothing but a bankers' combination hastily improvised can check the devastating decline. Perhaps, when the London Stock Exchange reorganizes in 1922 on its old basis, without further government meddling and regulation, Parliament will repeal this law and substitute, as a protection to bank stocks, that complete and constant publicity which is always the public's best safeguard.

Protection of Listing Requirements

When Charles H. Dow wrote, twenty years ago, of speculation generally, and incidentally of his theory of the market movement, some of the industrial stocks, included in the average and traded in freely on the floor of the Stock Exchange, were in what was then called the unlisted department. It would be difficult to imagine The Wall Street Journal speaking to-day of one of the industrials in the Dow-Jones average as a blind pool. But it did not hesitate to apply that epithet, editorially, to the American Sugar of Henry O. Havemeyer's day. The elimination of the New York Stock Exchange's unlisted department is dne of the most creditable instances of reform from within. It was bitterly opposed by some conservative members of the Stock Exchange, mainly those who profited largely by that vicious vested interest. An ex-president of that institution, now dead, took upon himself to berate me loudly, in the presence of his customers, for advocating that eminently necessary reform. Pie said that such agitators were driving business away from the Wall Street in which they earned their living. He threw out of his office the newspaper and the financial news service with which I was and am connected.

But his own customers made him reinstate both, with humiliating celerity. American Sugar and Amalgamated Copper and the other formerly unlisted securities are still dealt in on the floor of the Exchange. Those companies saw that they laid their management under the gravest suspicion by a refusal to comply with the terms of publicity so wholesomely exacted from reputable companies. Stock Exchange houses are naturally inclined to look askance at reforms advocated from outside. But I have never heard one of them even suggest the restoration of the unlisted department.

Federal Incorporation

It was said in an earlier discussion that something further might be done for the protection of the public, without the enactment of any of these u blue-sky" laws which only embarrass honest enterprise without seriously impeding the operations of the crook. In this discussion I can briefly set forth the sane and successful method which protects the speculator and investor in Great Britain. Under what is there called the Companies (Consolidation) Act of 1908 the London Stock Exchange is enabled to deal in any security the moment it is registered at Somerset House, London. That registration cannot be made until the fullest possible disclosure of purposes, contracts, commissions and everything else has been made. However adventurous the purposes of the company may be, the speculator knows all about them from the start. After that, under this statute, the old common-law rule of caveat emptor let the buyer beware prevails. It is properly held that the buyer can protect himself, as he should, when he can find out all about the property, its origin and its present conduct, for the fee of a shilling, at Somerset House.

There would doubtless be all sorts of ignorant opposition to Federal incorporation of this kind, with the law enforced and the public protected through limitation in the use of the mails. But I am convinced that it might well be done, and should, of course, be done in a strictly non-partisan spirit. To the utmost of its ability the New York Stock Exchange protects its members and their customers. But the New York Curb Market Association is simply an unlisted department in itself. I have no reason to believe that its government is not capable and honest, and I have not a word to say against its membership. But sooner or later it is calculated to prove a source of danger and scandal. If any of its members imagine that they have something to lose, in the setting forth of the absolute and original facts about everything in which they deal, they are making exactly the same mistake that ill-advised members of the New York Stock Exchange made when they shirked the disagreeable task of compelling a number of industrial corporations to comply with the listing requirements, on pain of being stricken from the list.

Real Reform from Within

Let me disclaim, however, the intention of crusading, or any bent toward that blatant and ignorant "reform" which has made such costly experiments in recent years. In my experience of it the standards of the Stock Exchange have steadily improved, to the permanent advantage of the investor and of the small speculator, who is, after all, only an investor in embryo. Practices were customary in Dow's day which would not be tolerated now. In any future bull market manipulation on the scale of James R. Keene, when he distributed Amalgamated Copper, would be impracticable, for the reason that the publicity now required by the Stock Exchange, in the accounts of such a company, would make it impossible to persuade the most reckless private speculator that the prospects of the new combination made it worth four times its book value, on any expert test. Even in those days "wash sales" were largely a figment of the public imagination, and "matched orders" were declined by any brokerage house of repute if their nature was suspected. The Stock Exchange rule against fictitious transactions is obeyed in spirit and in word. It was not a mere letter even in those days, whatever it might have been forty years ago, when the infant giant of American industry was only awakening to consciousness of his strength.