WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
In the last blog we introduced options. I had indicated that we would discuss another form of derivative in this blog, but I think we should first explore options in depth. There are two types: calls and puts. Both types of options are traded on various exchanges, and the options fluctuate in price in line with the changes in the price of their underlying asset, Traders on the exchange will buy or sell both types of options, puts and calls, throughout the trading day as the prices of the underlying assets vary. There are options traded around the world representing almost every type of commodity and financial asset. For purposes of this blog, we will look only at options on publicly traded stocks.
A call option gives the purchaser of the option the right to purchase one hundred shares of a stock for a fixed price (the "strike" or "exercise" price) for a set period of time (the "life" of the option). The purchaser pays the going market price for the option. The purchaser of the call is betting that the price of the underlying asset, such as a stock, will increase beyond the strike price. The purchaser can either exercise the option and then sell the stock at a greater price in the market or receive the value of the option above the strike price. In either case, the purchaser has made money. As we know, for every buyer, there must be a seller. The seller of a call option receives the option price paid by the purchaser. The seller is betting that the price of the stock does not exceed the strike price by the expiration of the "life" of the option. If the market price of the stock does not exceed the "strike" price by the end of the option's "life", the seller of the call option keeps the money paid by the purchaser for the option. Aside from accepting the risk, the option price received by the seller is "free" money. If the market price of the stock at the end of the time for exercise remains below the strike price, the purchaser has lost only the money paid to the seller for the option. If the market price of the stock at the end of the exercise period is above the strike price, the purchaser "calls" for the stock at the strike price from the seller of the option and resells it at the market price for a profit. Assuming the seller of the option had to go into the market to buy the stock to fulfill the option contract, the seller of the option has a loss, i.e., the current stock price which he or she had to pay for the stock less the option price the seller received at the beginning of the contract and the strike price, i.e., the amount paid by the purchaser upon exercise of the option. The allure of the call option for the purchaser is that the amount of profit is hypothetically unlimited, but the amount of the loss is limited to the option price paid at the beginning of the contract.
A put option is the exact opposite of a call option. A put option gives the purchaser of the option the right to sell one hundred shares of a stock to the seller of the option for the strike price for the life of the option. The purchaser of a put pays the market price for the option. The purchaser of a put option is betting that the price of the stock will decline below the strike price. The purchaser can then exercise the option; buy the stock in the market at the lower price and "put" it to the seller of the put option at the strike price for a profit. Just like the seller of a call option, the seller of a put option hopes the option will expire without being exercised, allowing him or her to pocket the price paid for the option. If the seller of a put option bets wrong, he or she is obligated to buy the stock at the strike price which would be above market price at the time of exercise.
So, to make things simple, if you think a stock price is going to rise, you can buy the stock itself, you can buy a call option on the stock at a strike price you think the stock price will ultimately exceed or you could sell a put option which, if the price rises, will expire unexercised and you can pocket the option price you received. If you think a stock price is going to decline, you can "short" the stock itself (I will explain this in a later blog), you can buy a put option on the stock at a strike price you think the stock price will decline below or you can sell a call option, which, if the price declines below the strike price, will expire unexercised and you pocket the option price you received.
In any of these cases, the trader is risking a lot less money than if he or she went into the market to buy a stock or to "short" it. In the case of the purchaser of either a call option or a put option, the loss is limited to the price paid for the option. The risk of loss is hypothetically unlimited for the seller of either type of option; however the option price represents extra money received for "free" by a seller who is convinced the stock price will act as the seller anticipates and the option will expire unexercised.
This is a link to a website with more information on options. In the next blog we will discuss another form or derivative, futures.
Comments are always welcome.
Monday, July 30, 2012
Monday, July 23, 2012
Options, Futures And Fantasy Football (1)
WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
Professional football is one of the most popular sports in America. Not satisfied with just watching their favorite teams, some sports fans developed a football game of their own in which they created their own teams composed of actual NFL players and matched their teams against teams organized by their friends. In its most basic form, participants create their own fantasy teams with real players from the NFL. Everyone who participates puts in an agreed amount of money at the beginning of the season. Based on the actual performances of his or her chosen players in NFL games each week, the "owner" of a team wins points. The owner of the fantasy team with the most points at the end of the real season wins the money. The performance of a person's fantasy team is derived from the performance over the NFL season of the players he or she has picked. Fantasy football has grown into a national phenomenon in the US and is played every week by millions of sports fans.
There is a similar investment "game" being played every day on various exchanges devoted to options and futures. On an options/futures exchange, people buy or sell assets, the value of which is based upon or, to be more accurate, is derived from the value of a different asset. Such assets are generally referred to as derivatives. One derivative, an option, comes in two forms: the right to buy an asset at a fixed price (a call option) or the right to sell the asset at a fixed price (a put option). In either case, the option expires at a predetermined time, after which it is no longer enforceable.
Options have a long history. During the tulip craze in 17th century Holland, there was a market for not only the actual tulip bulbs, but also for options on the bulbs. Options have been used by farmers for centuries. The farmers' problem is the possibility that the price of the crop they plant in the spring may drop by harvest time to such a degree that the farmer faces a loss. By selling the crop in advance for delivery when harvested, the farmer will have a guaranteed return on the crop. The purchaser of the option on the crop, maybe a food processor, has secured delivery at a known cost. Traders buy options and hope to realize a profit if the market price of the crop has increased by harvest time. Supposedly, there was an exchange in Japan in the 18th century for rice farmers to sell their crop before the harvest.
The Chicago Board of Trade (CBOT) was established in 1848. Forward contracts for various commodities on the CBOT were standardized around 1865 and have been traded on that exchange ever since. Today, there are numerous options exchanges around the world trading in virtually every type of commodity. Forward contracts in financial instruments were introduced in Chicago in the 1970s and have grown rapidly world wide ever since.
The appeal of options to traders is that the profit potential is large while the loss is limited to the price paid for the option if it expires without being exercised. Much less money need be invested in order to have a chance at a profit. As an example, assume you have decided that a particular stock is going to increase in price. The stock is trading at $10 per share and you have $100 to invest. For purposes of this example, we will ignore the transaction costs, so you buy 10 shares. Assume you are right and the price goes to $20 per share in three months. You will have doubled your investment. If, however, you had purchased a publicly traded option or future contract on that stock with your $100, your gain might be more than if you had just purchased the actual stock. The value of your investment tracks the value of the underlying stock, increasing or decreasing in step with the security. In order to increase the potential profit, derivatives traders will borrow money from the broker (a margin loan) and invest the loan proceeds. As a result, the profits could be much greater than if a person were to simply purchase the underlying stock with or without a margin loan.
In the next blog we will look at other derivatives.
Comments are always welcome.
Professional football is one of the most popular sports in America. Not satisfied with just watching their favorite teams, some sports fans developed a football game of their own in which they created their own teams composed of actual NFL players and matched their teams against teams organized by their friends. In its most basic form, participants create their own fantasy teams with real players from the NFL. Everyone who participates puts in an agreed amount of money at the beginning of the season. Based on the actual performances of his or her chosen players in NFL games each week, the "owner" of a team wins points. The owner of the fantasy team with the most points at the end of the real season wins the money. The performance of a person's fantasy team is derived from the performance over the NFL season of the players he or she has picked. Fantasy football has grown into a national phenomenon in the US and is played every week by millions of sports fans.
There is a similar investment "game" being played every day on various exchanges devoted to options and futures. On an options/futures exchange, people buy or sell assets, the value of which is based upon or, to be more accurate, is derived from the value of a different asset. Such assets are generally referred to as derivatives. One derivative, an option, comes in two forms: the right to buy an asset at a fixed price (a call option) or the right to sell the asset at a fixed price (a put option). In either case, the option expires at a predetermined time, after which it is no longer enforceable.
Options have a long history. During the tulip craze in 17th century Holland, there was a market for not only the actual tulip bulbs, but also for options on the bulbs. Options have been used by farmers for centuries. The farmers' problem is the possibility that the price of the crop they plant in the spring may drop by harvest time to such a degree that the farmer faces a loss. By selling the crop in advance for delivery when harvested, the farmer will have a guaranteed return on the crop. The purchaser of the option on the crop, maybe a food processor, has secured delivery at a known cost. Traders buy options and hope to realize a profit if the market price of the crop has increased by harvest time. Supposedly, there was an exchange in Japan in the 18th century for rice farmers to sell their crop before the harvest.
The Chicago Board of Trade (CBOT) was established in 1848. Forward contracts for various commodities on the CBOT were standardized around 1865 and have been traded on that exchange ever since. Today, there are numerous options exchanges around the world trading in virtually every type of commodity. Forward contracts in financial instruments were introduced in Chicago in the 1970s and have grown rapidly world wide ever since.
The appeal of options to traders is that the profit potential is large while the loss is limited to the price paid for the option if it expires without being exercised. Much less money need be invested in order to have a chance at a profit. As an example, assume you have decided that a particular stock is going to increase in price. The stock is trading at $10 per share and you have $100 to invest. For purposes of this example, we will ignore the transaction costs, so you buy 10 shares. Assume you are right and the price goes to $20 per share in three months. You will have doubled your investment. If, however, you had purchased a publicly traded option or future contract on that stock with your $100, your gain might be more than if you had just purchased the actual stock. The value of your investment tracks the value of the underlying stock, increasing or decreasing in step with the security. In order to increase the potential profit, derivatives traders will borrow money from the broker (a margin loan) and invest the loan proceeds. As a result, the profits could be much greater than if a person were to simply purchase the underlying stock with or without a margin loan.
In the next blog we will look at other derivatives.
Comments are always welcome.
Monday, July 16, 2012
Hope Is Not A Plan
WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
As we have seen from past blogs, a certain percentage of market action and many stock purchases are based on psychological, not financial, factors. Professor Malkiel captured the essence of this in his book, A Random Walk Down Wall Street, when he pointed out, "Stocks are bought on expectations -- not on facts."*
In his book, When To Sell - Inside Strategies for Stock-Market Profits, Justin Mamis discussed expectations as follows:
Stocks are bought not in fear but in hope. No matter what the stock did in the past, it assumes a new life once a purchaser owns it, and he looks forward to a rosy future -- after all, that's why he singled it out in the first place. But these simple expectations become complicated by what actually happens. The stock acquires a new past, beginning from the moment of purchase, and with that past come doubts, new concerns, new conflicts. The purchaser's stock portfolio quickly becomes a portfolio of psychic dilemmas, with ego, id, superego, and reality in a state of constant battle...especially since, in the stock market, one is never quite sure what the reality is.**
He went on to advise his readers to consider carefully the reasons for their stock purchases:
Let's be straightforward about it: the widespread and deep-rooted neuroses that affect virtually all decisions in the stock market are the subject for a different kind of analysis. Stock-market analysis is the task of separating real possibilities from mere hopes. And the path to doing this successfully is by concentrating on what you do know because it is actually happening -- current prices, volume, statistics, etc. -- rather than on what might happen or should happen.**
(Author's emphasis in bold)
Adam Smith in The Money Game quoted from Gerald Loeb's book, The Battle for Investment Survival, concerning hope and other factors which impact stock prices:
Market values are fixed only in part by balance sheets and income statements; much more by the hopes and fears of humanity; by greed, ambition, acts of God, invention, financial stress and strain, weather, discovery, fashion and numberless other causes impossible to be listed without omission.***
Every individual, whether investing for the long term or speculating for a quick profit, must learn to recognize the emotional forces which prey upon him or her and curb them to the extent possible. Since we are human, we can never fully succeed in this task, but that does not mean we shouldn't make the effort. One of the best ways to reduce the emotional aspects of stock purchases and ownership is to remember Adam Smith's advice: "The stock does not know you own it."
* Excerpt from A Random Walk Down Wall Street
by Burton G. Malkiel, copyright 2012, 2011, 2007, 2003, 1999, 1996, 1990, 1985, 1981, 1975,
1973 by W.W. Norton & Company, Inc is used with permission of W.W.
Norton & Company, Inc.
** Excerpts from When To Sell - Inside Strategies for Stock-Market Profits, Justin Mamis, copyright ©1994, published by Fraser Publishing Company, are used by permission of the publisher and Mr. Mamis.
*** Excerpt from The Money Game by Adam Smith, copyright © 1967, 1968 by Adam Smith published by Random House, Inc., page 22.
Comments are always welcome.
As we have seen from past blogs, a certain percentage of market action and many stock purchases are based on psychological, not financial, factors. Professor Malkiel captured the essence of this in his book, A Random Walk Down Wall Street, when he pointed out, "Stocks are bought on expectations -- not on facts."*
In his book, When To Sell - Inside Strategies for Stock-Market Profits, Justin Mamis discussed expectations as follows:
Stocks are bought not in fear but in hope. No matter what the stock did in the past, it assumes a new life once a purchaser owns it, and he looks forward to a rosy future -- after all, that's why he singled it out in the first place. But these simple expectations become complicated by what actually happens. The stock acquires a new past, beginning from the moment of purchase, and with that past come doubts, new concerns, new conflicts. The purchaser's stock portfolio quickly becomes a portfolio of psychic dilemmas, with ego, id, superego, and reality in a state of constant battle...especially since, in the stock market, one is never quite sure what the reality is.**
He went on to advise his readers to consider carefully the reasons for their stock purchases:
Let's be straightforward about it: the widespread and deep-rooted neuroses that affect virtually all decisions in the stock market are the subject for a different kind of analysis. Stock-market analysis is the task of separating real possibilities from mere hopes. And the path to doing this successfully is by concentrating on what you do know because it is actually happening -- current prices, volume, statistics, etc. -- rather than on what might happen or should happen.**
(Author's emphasis in bold)
Adam Smith in The Money Game quoted from Gerald Loeb's book, The Battle for Investment Survival, concerning hope and other factors which impact stock prices:
Market values are fixed only in part by balance sheets and income statements; much more by the hopes and fears of humanity; by greed, ambition, acts of God, invention, financial stress and strain, weather, discovery, fashion and numberless other causes impossible to be listed without omission.***
Every individual, whether investing for the long term or speculating for a quick profit, must learn to recognize the emotional forces which prey upon him or her and curb them to the extent possible. Since we are human, we can never fully succeed in this task, but that does not mean we shouldn't make the effort. One of the best ways to reduce the emotional aspects of stock purchases and ownership is to remember Adam Smith's advice: "The stock does not know you own it."
* Excerpt from A Random Walk Down Wall Street
by Burton G. Malkiel, copyright 2012, 2011, 2007, 2003, 1999, 1996, 1990, 1985, 1981, 1975,
1973 by W.W. Norton & Company, Inc is used with permission of W.W.
Norton & Company, Inc.** Excerpts from When To Sell - Inside Strategies for Stock-Market Profits, Justin Mamis, copyright ©1994, published by Fraser Publishing Company, are used by permission of the publisher and Mr. Mamis.
*** Excerpt from The Money Game by Adam Smith, copyright © 1967, 1968 by Adam Smith published by Random House, Inc., page 22.
Comments are always welcome.
Monday, July 9, 2012
Microscope, Telescopes & Satellites (3)
WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
The last of our instruments is the satellite which gives a global perspective in distances. In our time horizon analogy, the satellite might cover many years, if not decades, of market action. It is basic human nature to seek order in chaos, and investors and speculators carry this instinct over into their market moves. They try to make some sense out of the seemingly random action that occurs each day in the market. One of the methods many market participants use to overcome this market confusion is to ascribe a cyclical aspect to the market. If you view the market as having cycles or "seasons" like nature, a certain level of comfort can be achieved and some sense can be made of market action.
In addition to creating the Dow Jones Industrial Average, Charles H Dow, the founder and first editor of the Wall Street Journal, wrote over two hundred editorials on the market in his financial newspaper. After Dow's death, William Hamilton, Robert Rhea and George Schaefer collected the editorials and organized them into what they named the Dow Theory, a term Dow never used in his lifetime. Under this theory, the market has three movements or cycles consisting of the "main movement" which may continue for anywhere from less than a year up to several years. This would be considered the major trend of the market during this period. The next longest period is the "medium swing" which lasts from several days to up to three months. It consists of any secondary or intermediate reaction to the main movement. The shortest period is the "short swing." These minor movements may continue from several hours up to a month or more. Many technical analysts believe that the Dow Theory is the foundation of modern technical analysis. All three of these movements are happening in the market at the same time.
Another well known cycle was developed by a Russian economist, Nikolai Dmitriyevich Kondratieff. It bears his name, the Kondratieff Wave. This cycle or wave covers a period of up to 50 years from beginning to end and is meant to expose major moves in commodity prices. It is also supposed to explain boom and bust cycles in capitalistic countries. Some of its followers believe it also accounts for social and political events. I mention it because it was popular in the 1990s, but I would point out that the investing careers of most individuals will not last for the duration of a complete 50 year Kondratieff Wave.
Another theory of cyclical movement was developed by an accountant, Ralph Nelson Elliott, in the 1930s. It is a form of technical analysis. Mr. Elliott published his book, The Wave Principle, in 1938. He believed that market prices moved in specific patterns based on prevailing crowd psychology, alternating between optimism and pessimism. His theory is popularly referred to as the Elliott Wave, which includes a five wave pattern and a three wave pattern. Elliott believed that the basis for his theory rested on the Fibonacci sequence of numbers, examples of which are found throughout nature. Wave analysis continues to be a component of technical analysis, and its most famous proponent today is Robert R. Prechter.
If you were to look at the stock market over the past 100+ years, you would see that the overall trend is up, marked, intermittently, by severe downward cycles and sharp recoveries. The basis for this may be nothing more than basic human nature. As Bradbury K. Thurlow pointed out in his book, Rediscovering the Wheel: Contrary Thinking & Investment Strategy, "the generic bias of nearly all investment approaches is positive". He went on to point out the following:
Because of our historical indoctrination in accepting the premise of a secular uptrend in stock prices, because investors are traditionally owners rather than sellers of assets, and because in America we have been taught that the road to success is in accentuating the positive, we think habitually of the plus factors that affect stocks and tend to minimize the minus factors.*
This may be the only cycle you should keep in mind. As to the rest of them, it becomes a matter of belief. Norman G. Fosback reviewed several cyclical theories in his book, Stock Market Logic, A Sophisticated Approach to Profits on Wall Street. He concluded his study as follows:
Most cycles are without doubt figments of the imagination. Nevertheless, strange things exist in the universe, and the ultimate resolution of the truth of cyclic phenomena must await future study. In the meantime, if cycles have a utility, it is in reminding us that "This, too, shall pass;" that no bull market or bear market lasts forever.**
* Excerpts from Rediscovering the Wheel: Contrary Thinking & Investment Strategy, Bradbury K. Thurlow, copyright ©1981, published by Fraser Publishing Company, are used by permission of the current copyright holder.
** Excerpt from Stock Market Logic, A Sophisticated Approach to Profits on Wall Street, Norman G. Fosback, copyright 1976, 1993, The Institute for Econometric Research, page 168.
Comments are always welcome.
The last of our instruments is the satellite which gives a global perspective in distances. In our time horizon analogy, the satellite might cover many years, if not decades, of market action. It is basic human nature to seek order in chaos, and investors and speculators carry this instinct over into their market moves. They try to make some sense out of the seemingly random action that occurs each day in the market. One of the methods many market participants use to overcome this market confusion is to ascribe a cyclical aspect to the market. If you view the market as having cycles or "seasons" like nature, a certain level of comfort can be achieved and some sense can be made of market action.
In addition to creating the Dow Jones Industrial Average, Charles H Dow, the founder and first editor of the Wall Street Journal, wrote over two hundred editorials on the market in his financial newspaper. After Dow's death, William Hamilton, Robert Rhea and George Schaefer collected the editorials and organized them into what they named the Dow Theory, a term Dow never used in his lifetime. Under this theory, the market has three movements or cycles consisting of the "main movement" which may continue for anywhere from less than a year up to several years. This would be considered the major trend of the market during this period. The next longest period is the "medium swing" which lasts from several days to up to three months. It consists of any secondary or intermediate reaction to the main movement. The shortest period is the "short swing." These minor movements may continue from several hours up to a month or more. Many technical analysts believe that the Dow Theory is the foundation of modern technical analysis. All three of these movements are happening in the market at the same time.
Another well known cycle was developed by a Russian economist, Nikolai Dmitriyevich Kondratieff. It bears his name, the Kondratieff Wave. This cycle or wave covers a period of up to 50 years from beginning to end and is meant to expose major moves in commodity prices. It is also supposed to explain boom and bust cycles in capitalistic countries. Some of its followers believe it also accounts for social and political events. I mention it because it was popular in the 1990s, but I would point out that the investing careers of most individuals will not last for the duration of a complete 50 year Kondratieff Wave.
Another theory of cyclical movement was developed by an accountant, Ralph Nelson Elliott, in the 1930s. It is a form of technical analysis. Mr. Elliott published his book, The Wave Principle, in 1938. He believed that market prices moved in specific patterns based on prevailing crowd psychology, alternating between optimism and pessimism. His theory is popularly referred to as the Elliott Wave, which includes a five wave pattern and a three wave pattern. Elliott believed that the basis for his theory rested on the Fibonacci sequence of numbers, examples of which are found throughout nature. Wave analysis continues to be a component of technical analysis, and its most famous proponent today is Robert R. Prechter.
If you were to look at the stock market over the past 100+ years, you would see that the overall trend is up, marked, intermittently, by severe downward cycles and sharp recoveries. The basis for this may be nothing more than basic human nature. As Bradbury K. Thurlow pointed out in his book, Rediscovering the Wheel: Contrary Thinking & Investment Strategy, "the generic bias of nearly all investment approaches is positive". He went on to point out the following:
Because of our historical indoctrination in accepting the premise of a secular uptrend in stock prices, because investors are traditionally owners rather than sellers of assets, and because in America we have been taught that the road to success is in accentuating the positive, we think habitually of the plus factors that affect stocks and tend to minimize the minus factors.*
This may be the only cycle you should keep in mind. As to the rest of them, it becomes a matter of belief. Norman G. Fosback reviewed several cyclical theories in his book, Stock Market Logic, A Sophisticated Approach to Profits on Wall Street. He concluded his study as follows:
Most cycles are without doubt figments of the imagination. Nevertheless, strange things exist in the universe, and the ultimate resolution of the truth of cyclic phenomena must await future study. In the meantime, if cycles have a utility, it is in reminding us that "This, too, shall pass;" that no bull market or bear market lasts forever.**
* Excerpts from Rediscovering the Wheel: Contrary Thinking & Investment Strategy, Bradbury K. Thurlow, copyright ©1981, published by Fraser Publishing Company, are used by permission of the current copyright holder.
** Excerpt from Stock Market Logic, A Sophisticated Approach to Profits on Wall Street, Norman G. Fosback, copyright 1976, 1993, The Institute for Econometric Research, page 168.
Comments are always welcome.
Monday, July 2, 2012
Microscopes, Telescopes and Satellites (2)
WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
As opposed to the short term trader, an individual whose time line is longer may be able to avoid some of the randomness of daily price movements. The long term investor could be thought of as looking through a telescope at a more distant time horizon. The question then becomes what he or she is looking at. A person who invests based on fundamental analysis can only look at a company's financial statistics from the past and the present in making an investment decision. However, a long term investor/speculator investing not on financial statistics but on Wall Street's "story" of a company and the expected success of its product or service may not be much safer than one who is trading on random action.
Adam Smith, in The Money Game, recounted a couple of sad, but true, such stock "stories":
In 1961 the whole world was going to go bowling, but in 1962 Brunswick managed to make it from 74 to 8 with scarcely a skid mark. In 1965 the whole world was going to sit and watch color television, but shortly thereafter Admiral, Motorola, Zenith and Magnavox collapsed like a souffle on which the oven door has been untimely slammed. It will happen again.*
One of the more famous eras of "story" investing happened in the 1960s and 1970s and was based on the idea of never ending growth. Wall Street professionals and individual investors became mesmerized by a group of large capitalization stocks on the New York Stock Exchange whose earnings and, therefore, stock prices were expected to rise for the "foreseeable future." The group included such companies as Avon, Coca-Cola, GE, Johnson & Johnson, Philip Morris, Sears, Roebuck and Walt Disney. These stocks were known as the "nifty fifty" and were seen as "one-decision" stocks. The idea was to buy these stocks and hold them forever since they could do nothing but increase in price. Just like the tulip bulbs in 17th century Holland, that is not how it played out. The bear market of 1973-1974 brought all of these stocks trading with price/earnings ratios of 40 and more back down to earth with substantial losses for those who continued to hold them throughout the fall.
Bradford K. Thurlow described this in his book, Rediscovering the Wheel: Contrary Thinking & Investment Strategy, as follows:
The 'one decision' investing philosophy of the early 1970s spread through the industry like wildfire, carrying all favored issues to fantastic heights, virtually without intervening reactions, until the fashion began to abate and the same issues began falling as excessively as they had risen earlier. The individual wishing to follow this game had powerful assurances of group support in the early and middle stages and could have profited handsomely had he been able to detect when that support was beginning to crumble -- a not too difficult task, in retrospect, if he avoided becoming emotionally involved in the theory. Contrarily, however, had he failed to become so involved earlier on, it would have been difficult for him to justify buying these stocks in the first place. Most of those who were early believers merely rode them up and back down again without understanding the nature of the elemental conflict that was taking place.**
In his book, Irrational Exuberance, Professor Robert J. Shiller pointed out that anyone who had purchased members of the "Nifty Fifty" in the early 1970s would have had to wait until the 1990s for the stocks to return to their former prices. Now that would certainly qualify such an individual as a long term investor, but it is hard to believe anyone kept the faith (and the stock) for 20+ years.
In the next blog we will look at the view from satellites in the market place.
* Excerpt from The Money Game by Adam Smith, copyright © 1967, 1968 by Adam Smith is used by permission of Random House, Inc.
** Excerpt from Rediscovering the Wheel: Contrary Thinking & Investment Strategy, Bradbury K. Thurlow, ©1981, published by Fraser Publishing Company, is used by permission of the current copyright holder.
Comments are always welcome.
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