Playboy Plays the Market

He Dropped by his Club for an early lunch and a few hands of friendly blackjack with a crony. After ordering the drinks and the chips, he had a phone brought to the table and spoke a brief order into it. Then he settled down to the serious business of getting an ace in the hole as quickly as possible. Several martinis, one lunch, and a good many hands of blackjack later, he placed a second phone call, gave a second order, and thus, while clipping his pal for $8.50, also earned a tidy $2000.

How? By purchasing, during his first call, 300 shares of Lefcourt Realty at 7-7/8, an outlay of about $2300. He was able to sell Lefcourt later that same afternoon for 14-1/2, and he was two grand to the good.

The blackjack was gambling; the stock transaction was speculation. There is a great difference between the two, and this article will explain it to you. It will also explain how this enterprising fellow could have made as nice a killing with a lot less cash than $2300. As you already know from glomming newspapers and magazines, people in all walks are jumping into the market, from ad execs to zymologists. They're getting a second income by adding up their spare time and their spare cash and investing them profitably in what is perhaps the most exuberant bull market in history. (In the speculexicon, a bull is a rising market, a bear a falling one.) Everybody's doing it, but not everybody's doing it right.

Too many people are gambling rather than speculating. Too many people, as one Wall Street pundit puts it, "are recklessly rolling dice in the market with the idea that it is one big crap shooting society."

The reckless amateur blindly picks a stock with much the same abandon as he picks a horse or spins the wheel of fortune. But, whereas a horse player, before taking a flier on a filly, may study the form charts or even look at the horse – not that this usually does him any good – the amateur speculator may know nothing at all about the stock into which he puts his money, when knowing something might easily do him some good.

Graphic illustrations of this heedless speculation are everywhere. In the zany 20s, a stock called Gold Dust (a maker of household cleaners) used to rise along with the gold group, just as today Seaboard Air Lines (a railroad) often responds bullishly when the airlines group goes up. A similar Alice-in-Blunderland approach to stock selection was seen when Alaska became a state: there ensued a wild rush to buy anything with the name "Alaska" in it. "They would even have bought a Baked Alaska if there was such a stock," recalls one broker. And, of course, any stock ending in "-onics" is still a magic word to unwary speculators.

This pure chance approach has paid off for a few, but the long-run odds are against it. Some, by latching onto a Lorillard (which went from 18 in 1957 to a high of 88 in 1958), an American Motors (1958 price range: 8-1/4 to 39), or a General Time (35 to 104 during the first five months of this year), and possessing the stubbornness, stupidity, or perhaps good sense to hold on as these stocks zoomed upward, have managed to come out ahead or even make fantastic killings, proving that they are lucky, but not necessarily smart. One such fortunate soul put $1200 into 400 shares of General Transistor (simply because it was an electronics stock), when it was first offered to the public for $3 a share back in 1956; this year, when the stock hit a high of 88, the 400 shares were worth $35,200. However, the usual experience of even those lucky enough to stumble onto a winner is to buy the stock after it has had a sudden surge upward, then get scared and sell out when it dips, after which, of course, the stock goes up again, attracting some more temporary hangers-on. Exact statistics are lacking, but most brokers, if pressed to the wall, will admit that nine out of 10 amateur speculators invariably lose their shirts, or at least some buttons, in the market.

Luck plays some role in the success of the expert or professional speculator, too. But he generally manages to come out ahead mainly because he knows what he is doing and leaves as little as possible to chance. Unlike the black-jack player, he can, to a great extent, control the odds against him and appraise his risks by making a careful study of the particular stock in which he may be interested and getting a pretty good idea when to buy and sell it. Then through certain well-developed techniques he can pyramid his profits to a staggering degree if he has hit it right, keep his losses to a minimum if he has guessed wrong, and, as a matter of fact, often make money whether the market goes up, down or sideways.

In truth, seasoned speculators think they take far fewer risks than the so-called investors. For our purposes, let's just say that an investor is interested in a stock primarily for income, whereas a speculator seeks a capital gain with income a decidedly secondary objective. They may sometimes buy into the same stock, but for different purposes, or, as Merrill Lynch's Lou Engel put it, "One man's investment may be another man's speculation."

Anyone who thinks he's playing it safe by putting his money into bonds,blue chips or the bank, argue the speculators, runs the risk of having his capital eroded by inflation. Interest or dividends of 3% to 5% a year don't seem to mean very much when your money loses buying power at the rate of 3% to 5% a year. In the past 20 years, the dollar has been cut in half, and in the next 30 years, according to a former Under-Secretary of the Treasury, the present 48-cent dollar may be worth only a dime.

The investor in blue chips had blue skies from 1950 to 1957, with some stocks doubling and tripling during that period. But many haven't been doing too well lately. Such sacred cows as American Can, Royal Dutch, Amerada and Standard Oil of New Jersey, to name only a few, are actually selling below their prices of a year ago, in the face of a market that has soared like Sputnik.

A good on-the-surface argument is often advanced by the conservatives in favor of buying the bluest blue chips, regardless of price, and sticking with them through thick and thin. It involves playing a popular Wall Street pastime which we can call "If." If – goes one of the typical exercises in this game – you had invested $500 a year in Goodyear Tire since 1929, your shares would now be worth $169,000, and in addition, you would have pocketed $38,000 in cash dividends (all before taxes, of course). True. But the only thing the many examples of this sort illustrate (they are even more impressive for stocks like IBM and Dow Chemical), is the advantage of hindsight over foresight. They also presuppose the existence of a mythical investor (they're never real ones), with the Job-like patience to hold onto a good stock and even buy more of it in both good year and bad.

Another fallacy in this game of looking back at missed opportunities lies in the fact that even the bluest of the blue chips often fade. Pennsy, for example, sold as high as 110 in 1929; this year it has been hovering around 17. A good argument can be made on behalf of buying carefully selected blue chips for the long pull (but not necessarily forever), re-examining them from time to time, and switching out of them if they seem likely to take a turn for the worse. And considerable fortunes have been made this way. But the biggest fortunes have been made by the speculators who take a shorter-term view of things and are willing to take a chance, often on the stocks of the more obscure and perhaps more vulnerable companies. To be perfectly honest, somewhat more risks are often involved in the process, but this is the price one should expect to pay for the bigger gains possible.

Those who will use their spare time for an intelligent study of the stock market have a better-than-even chance of coming out ahead – and perhaps even getting rich quick – by emulating the techniques of successful professional speculators like Roman Shvetz.

A chunky man in his middle fifties, Shvetz puts in eight hours a day at his office at 79 Wall Street doing nothing but buying and selling stocks, and the week seldom goes by when he doesn't trade 40,000 or 50,000 shares with a total value running into six or seven figures.

Born in Russia and trained in China as a civil engineer, Shvetz gave up a high-paying partnership in a prospering export-import firm here in 1952 to devote all his attention to what, up to then, had been a spare-time obsession of his. (continued on page 72)Market (continued from page 70) Starting from scratch, he read every book he could find on the stock market, now subscribes to nine financial newspapers and periodicals, admits that he has but touched the surface.

Like most speculators, Shvetz generally steers away from the blue chips, although he will occasionally take a flyer in a stock of this quality if he feels it is due for a fast rise (for example, Chrysler, early this year).

He also prefers small, growing companies ("After all, an electronics company with sales of only five million or 10 million dollars a year has a better chance of doubling than a Westinghouse with its sales of two billion"), and particularly shuns stocks that pay dividends ("If they're too high, that's grounds for suspicion; besides, dividends are taxable as regular income").

If possible he holds a stock for more than six months ("Just long enough so that the long-term capital gains are taxable at only half the usual rate, up to a maximum of 25%"), although many of his deals are also closed out in a couple of months, weeks or days ("If I wait too long after a rise, the stock may go down again and then I don't make anything, taxes or no taxes").

Experienced speculators also do not follow the popular investor's practice of diversification; that is, spreading their risk by putting their money into many different stocks. "To diversify too much," says one pro, "is a sign that you're not too sure of yourself. On the other hand, if you concentrate on just a few stocks, you're going to be sure to take the time to study them pretty carefully."

Seasoned speculators will rarely follow the practice of dollar averaging (buying more of the same stock as it drops in price), but they will often pyramid or average up, and keep buying a stock as it continues to go up in price. "That means," says E. F. Hutton's famed Gerald Loeb, "I believe in following up one's successes and minimizing one's failures."

One of the things that distinguishes the really skillful speculator is this ability to capitalize on any given situation and squeeze the last drop of profit out of it – and often with a minimum of one's own cash tied up in the transaction; that is, on credit.

Wall Street's euphemism for credit is, of course, "margin," a term which was considered quite a dirty word circa 1929. Buying a stock on margin is something like buying on the installment plan but not quite. The similarity is that margin is a sort of down payment, representing the proportion of the price of a stock you have to put up in order to buy it, the broker lending you the rest at a rate of interest. The difference is that you never have to make any additional payments unless the price of the stock goes down. On the other hand, if the stock goes up, some wonderful maneuvers are possible – though not as possible as they were back in those giddy days of the 1920s when margin requirements were as low as 10%, or just a dime on the dollar. This meant that to buy $10,000 worth of stock, you had to put up only $1000 in cash.

With this leverage – as the device of doing a lot with a little is called in financial circles – quite a few people were able to run a shoestring into a fortune, and often back into less than a shoestring in practically no time at all. Because this free and easy use of Wall Street credit did to a great extent hasten the onset of the 1929 crash, Congress in the early 1930s gave the Federal Reserve Board the power to regulate margin requirements, and since then they have ranged (depending on the exuberance of the market) anywhere from 40% to 100%. They are now 90%.

However, lots of people are still playing the game, but differently. For every sophisticated speculator knows a number of devious and yet perfectly legal methods of escaping the present 90% margin requirements and playing the market with much more than the 10% credit his broker allows him. These methods, combined with certain other esoteric money-stretching techniques, permit him to do business in more or less the old way.

Special money brokers (some advertise in the Wall Street Journal, or your brokerage firm can put you in touch with them) lend you up to 85% or even 90% on any stocks other than outright cats and dogs at an interest rate of 1% a month, holding the stock as collateral. "This may seem high," says one broker, "but if your 100 shares of a $50-stock move up half a point, this covers the interest and everything above it is profit." Banks are another source of credit at considerably lower rates – usually 5% to 6% a year – lending up to 50% on over-the-counter stocks (those not traded on registered stock exchanges) and up to 80% or 85% on bonds. Banks also lend up to 70% on listed stocks, too, but with the stipulation that the loan not be used for the purpose of carrying these stocks or buying other listed securities.

However, there's always a legal way out for the adroit. Those who do not wish to run afoul of the letter, if not the spirit, of the law, simply get loans on "convertible" bonds. A convertible bond is a mongrel (but perfectly respectable) form of security that can be converted into (that is, exchanged for) the company's common stock at will. It was once described by a financial writer as "a security for a man who cannot make up his mind whether he is investing or speculating – that is, whether he wants the relative safety of a bond or the volatility of a stock." Because a convertible bond, through this feature, theoretically lets a man have his cake and eat it (it is supposed to sink only slowly and act like a bond when the market goes down and zoom up like a stock when the market goes up), and also often pays a fairly decent return (generally anywhere from 4% to 6%), many can be found in even the most conservative portfolios.

And there are other reasons why gentlemen prefer bonds (convertible). They are favorites of speculators who find in them a means of getting around the customary margin requirements for stock and, in addition, they offer a greater profit potential than that provided by buying or borrowing against the stock into which the bond is convertible.

A prime example of this technique in action is the experience of a speculator who last October decided that Northrop's 4% convertible bonds due in 1975 were a good buy. Each $1000 bond (convertible into 36.7 shares of Northrop common at $27.25) was then selling for $1030, slightly above par. The speculator decided to buy 300 of them after first arranging with his bank to finance 85% of the $300,000-plus involved in the transaction, with him putting up the other 15%, or about $45,000. Interest rate charged him on the collateral loan was 4-3/8% or only 3/8% more than the 4% he was getting on the bonds. (On some bonds, the interest rate is high enough to give you a "free ride" on the bank loan, or even give you a little profit.) By mid-May of this year when he decided to sell out, each bond was worth $1630. Total profit on his $45,000 investment: $180,000.

However, let's get one thing straight about working a deal of this sort with convertibles. The risk is greater, too. Had the bonds, held as they were on 85% credit, dropped even a bit in price, the speculator would have had to fork over more money to the bank. And had they dropped $150, his original $45,000 would have been wiped out completely.

There are a number of other ways that permit you to escape that 90% margin requirement. One Federal Reserve Board regulation, for example, provides a neat loophole by allowing you to acquire stock "rights" and "when issued" stock – the new stock issued after a stock split – for down payments as low as 25%. (A stock split occurs when, for example, a corporation withdraws its stock that is selling for, say, $100 a share and issues to the stockholders two shares of new stock worth $50 apiece.)

Commodities – wheat, eggs, rubber, (continued on page 74) Market (continued from page 72) lard – can be picked up for a 5% to 10% margin. U.S. Treasury Bonds can be gotten for as little as 5% margin, and a mere 3% cash down payment will purchase gold on the Canadian market.

Still other sources of leverage are possible through the use of such devices as warrants and put and call options. Both, in somewhat different ways, enable you to maintain a position in a lot of stock for comparatively little money.

A warrant is an option that gives the holder the privilege of buying a share of stock (from the company itself) at a fixed price within a stipulated period, anywhere from one to as much as 10 years or longer. A warrant is traded like stock. Most warrants (there are about a hundred different ones currently outstanding) are traded in the over-the-counter market; about a dozen are listed on the American Stock Exchange.

The famous RKO warrant illustrates how warrants work. First issued by RKO in 1940 after a reorganization of the company, it was good to buy a share of RKO stock at $15 (for a period of 10 years). In 1942, however, the company stock was selling for only $2.50 and the warrant commanded a price of 6-1/4ø – seemingly expensive even at this price. For, you reason quite sensibly, why should I pay even 6-1/4Ø for a piece of paper which gives me the dubious privilege of putting up another $15 for a stock that I can now buy on the open market for $2.50? The only logical reason for you to risk even the 6-1/4ø would be if you felt very bullish about the stock and thought it would go up considerably, though not necessarily to its conversion price of $15. If this were to happen (and at the time it did seem rather unlikely), you could do much better by putting $500 into the purchase of 8000 warrants than the same amount of money into 200 shares of the stock. For – and here lies the beauty of warrants – any big swings in the price of a stock are bound to be greatly magnified in the price of its warrant.

Let's look at the RKO picture four years later. The optimists were right: the stock had moved up to $28 and the warrants to $13. The $500 investment in the stock would have appreciated 11 times to $5600. And the $500 worth of warrants would have grown to $104,000, multiplying over two hundred times, or about 20 times faster than the stock.

The bestial side of warrants, of course, is that they can also go down just as fast as they go up. For, unlike stocks, warrants are merely pieces of paper which represent no equity in the business of the company, pay no dividends, and approach a value of zero as their expiration date nears – often, alas, just too soon for you to cash in on their potential.

Because warrants offer their best opportunities when available at mere fractions of the price of the stock – a situation most likely in a depressed market – there are very few, if any, penny warrants around today. But quite a few selling at anywhere from a half to a third of the price of the stock can still be picked up.

They won't permit the same fabulous profits possible with the classic examples given but nevertheless are a useful speculative tool if you have good reason to believe that the stock to which they are tied is going to move up.

A few words of caution, however: don't buy warrants whose expiration dates are not at least a few years off. And don't buy them with the same blind abandon with which many people buy penny stocks. For even if the warrants are cheap, you can still lose everything you sink into them.

Puts and calls, perhaps the most curious creatures of the financial world, are still other types of options, but, unlike warrants, are not traded in the market. In principle, these options work very much like real estate or similar business options. For example, a speculator decided that there was some money to be made in Lorillard when it was priced at $19 (back in 1957). Following the normal procedure, he could have bought 200 shares of the stock by laying out $3800 (or somewhat less by buying the stock on margin). But he didn't want to tie up all this money in the stock market at the time. Moreover, he didn't want to risk losing much of the $3800 in the event that Lorillard went down instead of up. So instead he paid $450 for a call that gave him the privilege of buying 200 shares of Lorillard at $19 anytime within the next six months. Five months later, Lorillard had jumped to $60. The speculator thereupon decided to exercise his call. Through his broker, he bought 200 shares of Lorillard for $3800, sold the stock immediately for $12,000, winding up with the difference of $8200 minus the $450 cost of the option, or a profit of $7800 less commissions and taxes. The beauty of this whole operation is that at no time did he stand to lose more than his $450, even had Lorillard dropped to zero. He simply would not have exercised his option. And had Lorillard risen to only 22, he could have retrieved all of the cost of his call. As it turned out, he walked away with a profit of 1700% on a rather minute investment. Had he decided, at the beginning, to put $3800 into the stock, his profit would have been just slightly more, roughly $8200, but this would have represented a return of only about 200% on his investment. So that you can savor all the possibilities of this gambit, let's say that he had decided to sink the whole $3800, not into the stock, but into calls. For this money he could have purchased 16 calls, giving him options on 1600 shares of Lorillard. His total profit, on the same basis, would have been $60,000.

There are a number of other reasons why you might want to buy a call, aside from the obvious purpose of trying for a big gain with a minimum of money. You may, for example, have to sell stock you own because of a need for ready cash and yet wish to maintain your position in the stock. Or you might want to insure yourself against a loss in connection with a "short" sale (more about this in just a moment).

A put is just the opposite of a call and gives you the right to sell a stock at a specified price during the life of the particular option. Obviously, the main reason you'd buy one is that you were bearish or pessimistic about a particular stock or, perhaps, the market in general. (It is easy to understand why, in recent years, calls have been more popular than puts.) Suppose, for example, you feel that General Dynamics, selling at $59, is due for a considerable drop in the next three months. For, say, $350, you buy a put option, giving you the right to sell 100 shares of General Dynamics at $59 anytime within the next three months. Should General Dynamics go up or remain at $59, your option is worthless and you're out the $350. If, on the other hand, General Dynamics goes down, say to $40, you buy 100 shares of the stock at that price on the open market through your broker and then, exercising your option, have him sell it for $59, coming out ahead by $1550 ($1900 less the $350 cost of the option), or a profit of almost 500% on your money in three months or less.

Speculators use puts for a variety of other reasons. They may be dubious about a stock they own and yet not wish to sell it. As an alternative to a stop-loss order – instructions to a broker to sell a stock if it drops below a certain price – they protect themselves against a big drop by buying puts as a form of insurance. They also provide a less risky alternative to selling a stock "short."

Puts and calls are available in periods of anywhere from 30 days to a year and unlike warrants can be secured for most actively traded stocks, one option usually covering 100 shares of the stock. Cost depends on the length of the option, the price of the stock and its volatility. You can have your broker buy them for you from one of the 26-odd members of the Put and Call Brokers and Dealers Association or order them directly from (continued on page 108) Market (continued from page 74) the put and call dealer, if you wish. The option dealers, in turn, get their puts and calls from people who think they can make money selling them (usually for the opposite reason you think you can make money buying them).

Naturally, profits in puts and calls are by no means a sure thing despite the examples given. If you go overboard on any old options just because they seem cheap, instead of getting options on stocks you have every reason to believe are going to move the way you want them to, you're almost certain to wind up with a wad of useless and pretty expensive paper. Not only must the stock move in the direction you want it to but it has to do so by a margin wide enough to cover the cost of your option as well as the commissions and taxes on the purchase and sale of the stock involved in the transaction. Options, too, have a fiendish way of expiring just as those promised golden riches are about to be reaped. To be on the safe side, stick to the longer term options (at least three months and preferably six), unless you're darned sure of your timing.

Another tricky technique, that of selling short, is well illustrated in the spectacular speculative career of Bill Stanley, a young, genial advertising salesman who also doubles as an early-morning disc jockey for WICH, a Nor-wich, Connecticut, radio station.

By a series of fortunate investments (Lorillard, Polaroid, Thiokol, Armour), and by using some of the aforementioned devices, Stanley, with no stock market experience, was able to pyramid $2800 into $41,000 in little over a year.

But he ran into trouble with American Motors. He first bought into it at $13 back in the late summer of 1958 and he kept buying more of it as it kept rising. By the end of the year it had risen to $41 and Stanley owned 1225 shares and calls on an additional 1800.

Had he cashed in his American Motors when it hit $43, a few weeks later, Stanley would indeed have achieved his goal of having $50,000 at the age of 30. But, like a lot of other people, he thought the stock was worth at least $48, maybe even $50, and so he hung on. Unfortunately, by this time the rumors of the Big Three entering the small-car field started to percolate and with them, American Motors took a nose dive, dropping to $25.50 within a matter of days.

To get out with his skin, let alone salvage whatever profits he could, Stanley resorted to that ordinarily risky speculative technique known as "selling short." Like most other stock market maneuvers, this feat of financial leger-demain is not profound but it is some-what complicated.

In a short sale, you can sell stock you do not own when you expect that its price will drop. In actuality, you borrow through your broker a certain number of shares of the stock and agree to replace them. In doing this, the short seller must still observe the margin requirements and put up cash equal to 90% of the value of the stock that he borrows and sells. You sell the borrowed stock at the market price and hope that the price of the stock will drop so that you will be able to buy it back cheaply to cover your loan.

But if you've guessed wrong and the stock starts to rise, you're in trouble. Sooner or later, depending on how long your nerves hold out, you'll have to pay more for the stock you buy than for the stock you've sold it for. The short seller also must pay the dividends due the person from whom the stock was borrowed.

Although the consequences of short selling are not necessarily so dire (in fact, plenty of money has been made by the technique), the reason short selling can be quite a risky business, compared to the standard practice of buying a stock first and selling it later, is very simple. If you were to buy a stock in the regular manner at, say, $16, the worst that could happen would be for it to go down to zero and the most you'd be out would be $16 per share. (Not that this isn't bad enough.) But were you to sell the stock short at $16 and it happened to go up, only the sky would be the limit on the amount of money you could lose. In fact, something almost this catastrophic happened with a stock called E.L. Bruce (flooring) a few years ago. It had been doddering along at $16 when suddenly, during a fight for management control, it shot up to $171 in a matter of months. Caught in the middle were some frantic shorts. Fearful that the stock could conceivably go up to $500, some did buy back at $171 to cover their short sales at 16. Those lucky enough to be short only 100 shares took a licking of $15,000 on the deal.

However, there are perfectly valid reasons for one type of short selling, one that involves no such risk. This is called "selling against the box" and is the maneuver that Bill Stanley resorted to in order to protect some of his paper profits in American Motors. In selling against the box, you sell short against stock in the same company that you actually do own. That is, your own stock serves as collateral against the stock borrowed for the short sale and no margin payments are required.

You might sell short against the box instead of selling your own stock outright when you feel that the stock may dip temporarily and then come back. If you've made a mistake and the stock doesn't go down at all but continues up, you have the broker deliver your stock in the box to cover your short sale. (You also eat your heart out by figuring the extra money you would have made if you hadn't sold short.)

When Stanley saw his American Motors start to slide from 43, he sold some of his stock outright and sold the rest short against the box when it hit 35, thus guaranteeing his 35, selling price for the shares he still owned and had put up as collateral. Had American then started to rise from 35, he would have delivered this stock to cover his short sales. But, as mentioned, American Motors continued to drop. As it fell in a wave of frantic selling (during one day a quarter of a million shares were traded), Stanley decided that enough was enough; he bought stock on the open market at $27 and delivered this newly acquired stock to cover his short sales, making eight points on the deal. When American Motors ultimately got back past 35 again, he sold out altogether, getting as much as 39 for some of his stock. Unfortunately, there wasn't much he could do about most of his 18 options: eight expired unexercised during this crucial period (total loss, $4600); on five he broke even, and on the remaining five made a total of $2500. All in all, he did manage to wind up about $8000 ahead on his stock and options, but ruefully figures he would have had $10,000 or $15,000 more had he sold out at $41 or $43.

It should be obvious that none of the many techniques described mean a thing unless you have some idea as to when to buy and sell a stock and how to pick a stock that is going to perform spectacularly better than average. Lacking this prescience, the same techniques of leverage that can be used to put you speedily on the mainline to wealth can, by operating in reverse, catapult you to the cleaners just as quickly.

About the only thing certain that can be predicted about the slock market, or an individual stock, complicated as its action is by the play of emotions, the frailties of human judgement and a host of other unpredictables is that – in Bernard Baruch's memorable words – "it will fluctuate."

Not that at least some of the factors responsible for the fluctuations can't be studied and analyzed. To predict the course of the market as well as that of individual stocks, Wall Streeters have tried a variety of approaches, some quite logical, some loony, and some literally out of this world (correlating the market with the frequency of sunspots, etc.).

The two most practical approaches are the so-called fundamental and technical ones and each has its own often devout adherents. To determine the probable course of the market, the fundamentalists, among other things, study and integrate the various barometers of business activity – such economic indicators as freight car loadings, industrial production, machine tool orders, commitments for new housing, business failures, and so on – or, in other words, "the fundamentals."

They believe, for example, that when freight car loadings are decreasing and the government is starting to ease up on credit (by lowering interest rates), a bear or declining market may be in the offing. This, in turn, may serve as a signal to switch from cyclical stocks (autos, aircraft, steel, mining, building, railroads, etc.) into defensive or relatively stable issues (foods, utilities, drugs, tobacco, etc.) or into bonds or, perhaps, to get the hell out of the market completely.

To determine the probable action of a particular stock and get some idea as to its present value, they look at its fundamentals too, and pore over balance sheets and statistical reports to study its earnings, dividend record, capitalization, ratio of assets to liabilities, and so on. Out of all this emerge several important yardsticks of which the one most frequently used to determine the market value of the stock is the so-called price-earnings ratio. If, for example, a company is earning $3 a share per year (after taxes) and its stock is selling for $45, it has a price-earnings ratio of 15, or in the vernacular of the Street, is selling for "15 times earnings." The blue chips used to compute the Dow-Jones industrial index are now selling at about 23 times their 1958 earnings.

Important and sound as the total fundamental approach may be, it unfortunately doesn't always provide the whole answer. The market has on several occasions been known to act opposite to the fundamental forecast.

Also, there is not necessarily any correlation between the action of the market as a whole and that of an individual stock. Nor do the fundamentals always offer a sure-fire means of determining what a specific stock should sell for. You can't always gauge this by the company's dividend, and the price-earnings ratio is not always a reliable guide.

Some good stocks are chronically underpriced year after year, whereas others, both good and bad, have recently been selling at astronomical P/E ratios. Ampex, for example, is selling at 85 times 1958 earnings, General Time at 77 times, Molybdenum at 358, and Royal McBee (which netted only 3c a share last year) at over 600 times earnings. If you take stocks like Chrysler which had deficits last year, a recent P/E ratio cannot even be computed at all.

There is an explanation why some stocks are often out of line with their statistical fundamentals. For one thing, a prosaic analysis of the past or even the present earnings of a company does not necessarily indicate what it will do in the future. These and other statistical fundamentals do not tell enough about other fundamentals such as the capabilities of the management (perhaps a new one) and the research department, the possibility of a merger or stock split (real or rumored), new products in the works, as well as other factors that may influence future earnings.

What, in the final analysis, determines the price of a stock, is not only its theoretical fundamental value, both present and foreseeable, but also what people, rationally or irrationally, think it to be worth. As Bernard Baruch put it, one of the problems of the speculator "is how to disentangle the cold hard economic facts from the rather warm feelings of the people dealing with these facts."

It was in failing to do this that Bill Stanley (and lots of other people) went astray in judging when to sell American Motors. On the basis of all the fundamentals, he should have been able to get $48 or $50 for the stock. With the company expected to earn around $10 a share this year, this price would have been only five times earnings. After all, General Motors, which was expected to earn only $3 a share, was already selling at $50, or about 17 times earnings.

Certainly, five times earnings should not have been too unreasonable a price to expect for American Motors, a company well in the black. But, faced with the fear of what the competition of the Big Three's compact cars would mean to Rambler, people simply would not pay more than four times earnings for American Motors stock, cheap as this might have seemed. Time, of course, may prove them wrong.

Because it is not entirely safe to rely on the fundamentals, many turn to a technical approach to the market. Some go as far as to shun the fundamental completely (even to the extent of not caring what business a company may be in) and use one or a variety of pet formulas to guide them in deciding when to buy and sell a stock.

The technicians compare the price trend of a stock with the volume of trading in it. They know, for example, that an increase in the volume of trading in a stock with a rising price is generally a bullish sign – a sign to buy (but not always); and that an increase in the volume of a stock with a falling price is generally a bearish sign – a sign to sell (but not always). They also often sell on "good news" – an announcement of a dividend increase, a good earnings report, a stock split – especially if the stock has already had a substantial price rise (the insiders have already been buying it up prior to the announcement, and have probably pushed the price as high as it is going to go). They study such things as the size and changes of the "short" interest position (apparently on the theory that the shorts are usually wrong and eventually have to buy back the stock they sold short, a large short position is considered bullish), the "odd lot" transactions or purchases and sales of stock in less than 100 share units, and know on the basis of precedent that the market is most likely to rise in July, August and December, and most likely to dip in February and September.

In a class by themselves are the comparatively small but dedicated cult of chartists. A chart, for which some form of graph paper is used, contains a periodic record of the ups and downs in the price of a stock and often also its volume. As the chart is kept, a pattern gradually emerges which, depending on the type of chart, usually looks like needlepoint or a series of jagged lines. From the particular pattern or formation the consecrated chart reader is supposed to tell what the stock is going to do and about when it is going to do it.

The strange thing is that in some mysterious way charts often do work, although there are also occasions when two chart readers looking at the same chart do draw from it two opposite conclusions. If a chart doesn't seem to work, the usual alibi of the chartist is that he didn't read it correctly.

The gratuitous advice from relatives, friends and minions is worth just about what you pay for it – nothing – and can, in fact, cost you a great deal of money in the long run. Even if reliable, it may reach you third – or tenth-hand, weeks or months after the stock has already gone up. In fact, one of the reasons tips trickle out from the insiders is that they can sell to you when the tips have you all hepped up. Most customers' men are honest and well-meaning,but their tips are usually at least third-hand, too. And you must remember that they don't get any commission unless you buy and sell. They're only human, and the more active accounts will invariably command their more concentrated attention.

Another grim fact of Wall Street life is that most of the advisory and statistical services also often fail – and often quite miserably – in their chosen task. A number of independent studies made by various organizations have shown that the financial forecasting services as a whole have been wrong anywhere from one-half to two-thirds of the time – worse than if they had just flipped a coin.

In view of all this, you ask, what chance do I, a complete novice or comparatively inexperienced speculator, have of making out well in the market or perhaps even getting rich quick in it? A pretty good chance – if you are willing to give it a real try. For, as the consistently successful speculators know through experience, the best answer to the question as to what stock to buy and when to buy and sell it is most likely to come through your own investigation.

How do you start? You can, like Bill Stanley and Roman Shvetz, read up on the mechanics of the market and the basic principles of speculation in the countless books available on the subject. Among the best are Gerald Loeb's classic The Battle for Investment Survival, The Sophisticated Investor, by Burton Crane, and Philip Fisher's Common Stocks and Uncommon Profits.

You can even subscribe to some of the financial magazines or read them in the public library or your broker's office, and listen to tips – as long as you use this information as leads to follow up on yourself. For leads as to what to buy, it also doesn't hurt to have friends high in financial circles, have an uncle who's a broker, or know a good security analyst. You can also gather a surprising amount of good information simply by keeping your ears open. Bill Stanley learned about Lorillard, for example, when the tobacco company sent some of its representatives around to his radio station to buy time and he then got wind of the big filter-tip campaign in the works.

After a while you may, like many seasoned speculators, show a partiality toward small companies with relatively small capitalizations, that is, with a small floating supply of shares on the market. For when attention is directed to such a company, price swings (up as well as down) are almost inevitable.

You'll learn that one of the generally accepted distinguishing marks of a "growth" company is that its earnings increase at the rate of at least 10% to 12% a year. You'll also learn that a stock is not necessarily a good buy merely because the company is in a growth industry (chemicals, electronics, nucleonics, metallurgy, etc.). Many, of course, will eventually fall by the wayside.

How do you pick a growth company most likely to zoom? Here again, the knowing pros look among the smallest good companies in a field. "Assuming adequate management and finances," says George Edgar, astute senior electronics analyst of Carl M. Loeb, Rhoades & Co., "find the smallest equity base that provides maximum exposure to a specific dynamic development. Or in laymen's language, pick the smallest company in the hottest field.

"Take the transistor field. There are about 10 companies in it who amount to anything. The giants like RCA, GE and Westinghouse are already too big and besides they've got too many irons in other fires and so you eliminate them. Among the smaller companies you find Texas Instruments. Not a bad buy, but its equity base (number of outstanding shares multiplied by price of stock) is now $500 million – maybe also already too big. Probably having a greater chance for maximum growth is General Transistor with its equity base of only $28 million.

Since leverage can work to the advantage of a company in much the same way it can for you, you may also find yourself favoring companies with high leverage, that is, those with a comparatively large amount of bonds and/or preferred stock outstanding. The reason is briefly this: with the interest and/or dividends paid out on these securities constant, the earnings applied to the company's common stock multiply considerably when business is good. However, as in other forms of leverage, the reverse is also true. If business is bad, the common stock earnings drop.

One of the most important things you'll have to learn is that it is useless ever to attempt to buy at the very bottom and sell at the very top. "The only people who can ever do this," says Bernard Baruch, "are liars." The decision when to sell is perhaps one of the most difficult the successful speculator has to make, because of the great part emotionalism plays in it. The biggest fault of the amateur is his persistence in holding onto a stock even though it goes down, down, down – in the delusion there is no loss if the stock isn't sold.

Above all – whether the decision is to sell or to buy – it will help you to know as much about the stock in question as possible. You can be a fundamentalist, a technician or a chartist, but it is obvious that there is something to be said for using the tools of each approach.

Bill Stanley, like Roman Shvetz, keeps charts as well as close tabs on the other technical factors likely to affect the price of the stocks in which he is interested, and he is also a student of the fundamentals. Before Stanley bought Lorillard he checked its sales at supermarket counters, dropped into drug stores and tobacco shops to ask clerks how Kent cigarettes were selling, pored over the company's sales figures in the tobacco trade journals. When he was considering buying American Motors, he visited auto dealers in practically all of eastern Connecticut to see how the Rambler was doing, looked into the various automotive trade journals to see at what rate Ramblers were being licensed. He now subscribes to eight different trade papers in various fields. He is not above phoning a company president at home if there is something he wants to know, or dropping in at a factory to pepper officials with questions, and he does it all in his spare time.

This then is the secret: research and keen analysis, the gift to grasp the sense of the stock situation and a little luck. Add a dash of patience to ward off cupidity and stupidity, an unsentimental nature so you can drop that favorite stock if it is obviously a loser, and some cool nerves that can take wide swings of the market with aplomb. It's an ancient but still true adage that scared money never wins on Wall Street.

Commissions and Taxes

In this article, brokers' commissions and taxes have been omitted for the sake of simplicity. The commission schedule is quite lengthy, but as a rule of thumb, if you buy or sell stocks in the medium price range in multiples of 100 shares, you can count on paying your broker about 1.2% on a single transaction. For "odd lots" – stocks in packets of less than 100 – your cost will be slightly higher per share. The commission on bonds is around .25%. Security Exchange Commission and state taxes on stock transactions are negligible.

The real tax bite is in the income tax, and here it is crucial how long you hold the stock. Profits from stocks held longer than six months are considered to be long-term capital gains, and are taxed at no more than 25%. Profits from securities held less than six months are short-term capital gains and are taxed as regular income, like salary or dividends. It is an important aspect of your strategy of market speculation to take this distinction into account.