The Theory of Stock Exchange Speculation. Arthur Crump
went half mad in the first half of 1873, which was followed shortly after by a financial crash and the suicides of certain bankers at Posen. Older communities, which have passed through the only crucible which in this life teaches people that if money is to be made rapidly the process must be attended with a proportionately large risk, are observed, as time goes on, to be less exposed to the headlong financial panics such as that in which the speculation at Vienna lately culminated. Commercial revulsions of one sort or another, and of greater or less violence, will probably occur during all time at intervals, wherever commerce is carried on, but the gradual fashioning of laws with the view to confine the injurious effects of over-speculation and over-trading within limited areas, as for instance the limited liability acts, will more and more render it possible to stand between the dupe and the financial sharper, and also to observe the gathering together for harm of the dangerous influences, so that they may be provided against in time, or checked at an early stage of the disease. Among the operators at younger commercial centres there is a more feverish desire to gain, but the efforts to satisfy it are not kept in check in the same degree as in places where memories of disaster cluster in traditions among the people, and inspire the growth of prudence, almost as if it were an instinct.
Farther on we shall call attention to the way in which an outside speculator on the Stock markets is handicapped with turns, commissions, and contangoes.[5]
Very few persons, if any, will be found to dispute the statement that speculation on the Stock Exchange is gambling. The highest mathematical authorities maintain that there are but two conditions under which gambling can be prudently followed as an amusement, viz.: small stakes, and equal play.
The ordinary gambler in the Stock market is no better off, as regards his chance of winning, than a player against a bank, which can only make certain of winning against all comers in the long run by the protection of a mathematical advantage. In the case of a bank established as a gaming-house the initial condition of existence has always been in the long run either bankruptcy to itself, or ruin to the individual players. As the banks have always flourished, the players, in the long run, must always have been losers.
A gaming-bank is an institution with limited means offering to play all who enter; or, in other words, it is limited means against unlimited means.
The Stock Exchange occupies a parallel position to that of the bank, and the operators[6] in the markets are protected in such a way that the outside player at speculation must in the long run lose, or no one would be found to take up his challenge. It must be obvious that supposing an outside speculator had any advantage when speculation in stocks and shares were first practised, and through such an inequality of terms he was on the average the gainer, experience would soon show the necessity of rectifying such a state of things, and what would be tantamount to the mathematical advantage secured to the gaming-bank would be speedily arrayed against him.
The number of people who play publicly at games of chance is very small compared with the number of people who gamble in mercantile transactions. And whereas the former are diminishing, partly from compulsion, as in the case of Germany of late, and partly through the more enlightened state of the human understanding as regards the immorality of this kind of amusement, the latter appear to multiply in proportion to the general increase of wealth, the ever enlarging fields in which public securities are dealt in and commercial transactions are negotiated, and also in proportion to the facilities afforded for speculation generally. The latter part of this sentence should, however, be qualified by the remark that the spread of wealth enables younger and less experienced persons to engage in speculation in a larger proportion as compared with the whole community than formerly. The difficulty of living and the ambition not to fall below the standard maintained by the well-to-do, tempt numbers of young men to endeavour to increase their income by speculation. And moreover as regards Stock Exchange speculation it is unfortunately much against the interest of the stock broker to make public the failure of his clients, hence it is seldom that the wholesome warning of publicity deters others from entering the arena.
Outsiders entering upon speculation with professional dealers in the Stock markets make two mistakes on the threshold. Firstly, they commence upon unequal terms, the effects of which adventitious favourable influences have never more than compensated for, in the long run. Secondly, supposing the terms were permitted to be equal, the outsiders’ stakes would be too large a proportion of their means. The losses incurred by speculators as a body have always been upon such a scale as to dispose of the theory advocated by some persons that the mere charges of commission, contangoes, and the “turn” are the only obstacles to success.
Now, if the playing of public games of hazard are on the decline from the interference of the State on moral grounds, the question arises: are there any considerations applying to Stock Exchange gambling, which, as a game, raises it above other games of chance, and entitles it to special privileges? Does the outside haphazard speculator stand a better chance as against the Stock Exchange, than a player at Rouge et noir against the bank? The answer must be No. Exactly the same considerations apply to commercial speculations as to other games of chance in which no absolute certainty exists. Mathematicians lay it down as a law, that if any possible event which cannot frequently occur in a game of chance, but which is, nevertheless, a part of the nature of the game, if a bet or stake be made upon the recurrence of that event in a proportion to some large gain which it is agreed that event shall secure, then prudence demands that the game shall be often played; and if this be impossible it shall not be played at all. Here we come to the crux of the whole question of Stock Exchange speculation. Unless a speculator, handicapped as we shall show he is to start with, has enough means to enable him to hold out for the arrival of the event, the occurrence of which is absolutely necessary to his keeping above water, he should not speculate at all.[7]
What is the one event constituting the benefit for which the speculator operates? it will be asked. The answer is, the greatest fluctuation in the direction favorable to him which may be caused by any one of the many influences that may spring into action at any time. This is part of the mystery which allures people on. If you tell persons who are throwing a die that the six will turn up once in six times in the long run, they can form some estimate of their chance of winning. But until a Stock Exchange speculator has been roughly undeceived, his understanding gets entangled so that what he sees clearly only at first, is what is in his favour, because his first interest is to discover that. What is against him, he disregards until he has discovered it has undermined him, and all goes together.
In cases where the public play against a bank, it is so managed that the bank has a better chance than the players. It is so managed that a considerable succession of losses can be sustained against the good luck of any comer. One side always secures to itself the benefits of the long run. The haphazard speculator stands at the same disadvantage as the player against the bank. His position is always relatively inferior. When the balance is nothing, as worked out by the following rule as stated by De Morgan, then the play is equal:—“Multiply each gain or loss by the probability of the event on which it depends; compare the total result of the gains with that of the losses: the balance is the average required, and is known by the name of the mathematical expectation.”
It must stand to reason that an outside speculator plays upon unequal terms, otherwise it could not be worth the while of the other side to engage him. As well might we expect a man to set up a shop and sell his goods at a loss. Then we come a step farther, and ask if it be any use for a Stock Exchange speculator to operate if the terms be equal? If such numbers of persons find themselves induced, by the estimate they are enabled to form of the chances in their favor, to play on terms more favourable to their antagonists than to themselves, their prospects would seem to be much improved if the terms were made equal. Although the position of the speculator be improved to the extent of the terms being equal, it is absolutely indispensable that the operations be kept open for a considerable time[8] in order to secure the mathematical expectation which can have no existence except through continuity. With the play in favour of the gambler, he stands no chance even of holding his own, unless he makes sure of being able to continue over such a number of trials, or during such a period of time, as will give him the benefit of an average of the ups as well as the downs of fortune.
As at cards so at Stock Exchange speculation, there must be two kinds