Playboy Plays the Stock Market

When stock prices were falling so suddenly last summer, at least one investor--H. Ross Perot of Dallas--wasn't hurting. The few Americans who know of Perot probably associate him with United We Stand, a nationwide lobby, of which he is chairman, that supports President Nixon's policies in Vietnam. (Perot tried unsuccessfully to get a planeload of Christmas gifts and food to U. S. war prisoners in North Vietnam last December.) But Perot also wears another hat, which makes him a fascinating representtative of the silent majority for which his organization speaks. Simply stated, Perot is the first person in history to make a billion dollars in the stock market in a single year--a feat he seems to have completed, perhaps significantly, during the moratorium month of October 1969.

True, he didn't go about it in the way an ordinary investor might; but then, your ordinary stock dabbler doesn't usually knock down ten figures a year, especially on an initial stake of only $1000, which is what Perot began with. And it shouldn't matter that Perot's profits are all on paper, because the importance of this event is symbolic. Here is a man who has accomplished what even the most turned-on Wall Street's under-30 multimillionaires still regard as fantasy.

Eight years ago, with his $1000, Perot founded Electronic Data Systems Corporation, a company that sells computer skills and systems to those who need them. His company prospered, and in the fall of 1968, Perot took it public. He sold 650,000 shares at $16.50 each, prudently retaining another 9,000,000 shares for himself. In a little over a year, when eager stock buyers were offering $136 a share for E. D. S., Perot found himself--on paper, anyway--a billionaire-plus.

It seems fitting that Perot should have completed this feat during October, which Mark Twain characterized as "one of the peculiarly dangerous months to speculate in stocks in." The other dangerous months, Twain continued, "are July, January, September, April, November, May, March, June, December, August and February." Since Twain lost more in stocks than he could earn even as a fantastically successful writer, the cynicism that colored his judgment is forgivable. Like most writers, he knew little or nothing about the stock market. In fact, a variation of the typesetting machine in which he invested--and which bankrupted him in the 1890s--subsequently made millions for investors with a better sense of timing. Twain also singled out the wrong month to steer clear of the market. As Perot's experience might attest, October happens to be a very good month to speculate in stocks in. Most of the declining markets of the past generation (1946, 1957, 1960, 1962 and 1966) turned around then, a curious coincidence that prompted a veteran Wall Street observer to proclaim that "October outranks all other months as a buying time" for short-term stock profits. Perot's good fortune can also be cited to confirm the observation--if it needs confirmation--that no single route to riches is swifter or more rewarding than the stock market.

At last count, roughly 27,000,000 Americans seemed to agree. These are the investors who (as the saying goes) own a share in American industry. Some of them may have purchased stocks to conserve their capital, others to avoid taxes, to hedge against inflation or to nail down a decent income to see them through retirement. A very few, like Perot, have created their stockholdings as an almost unanticipated by-product of their own foresight and hard work in forging a corporate empire. But the vast majority of stock players these days, silent or vociferous, are in the market with just one goal: to make money; and, whether the market is going up or down, a surprising number succeed.

Stated in its simplest terms, transactions in the stock market involve (continued on page 130)Stock Market(continued from page 127) sheets of paper called shares, or stock, representing fractional ownership of a corporation. Some companies, of course, are privately held; while they have shares and shareholders, it's impossible for the public to invest in them. But the preponderance of the nation's largest companies are publicly held, with ownership spread among hundreds, thousands or even--in the case of the telephone company--millions of shareholders. Companies issue stock for one reason, to raise money; and long experience shows that money is most easily raised when potential investors know they can subsequently sell their shares--it's to be hoped--for a profit. Thus, the stock market developed: to provide a convenient gathering place for would-be buyers and sellers.

Marxist critics of capitalism enjoy pointing out that money changing hands in the stock market rarely reaches the corporations involved, giving the game a surrealist irrelevance. This is true, but no more useful than observing that poker winnings don't usually go to the manufacturer of the playing cards. Without a ready market for corporate shares (economists call it a liquid market), companies could never raise the money with which to begin or expand their operations. People would never buy a stock unless they knew they could ultimately sell it. The liquidity of the market place is one of the basic underpinnings of capitalism as we know it, and today it is seriously threatened, for the first time in history. Mutual funds and other huge institutional investors have grown so fat that they are finding it increasingly difficult (sometimes impossible) to sell the large blocks of shares they have accumulated. As a consequence, stock prices are bouncing around with a vehemence that would have been unimaginable just a few years ago. But this is good news for the small investor. The market is still liquid enough to accommodate any transaction he is likely to make, and the problems that plague the institutions only create more action--and profit--for the individual.

Before the investor begins playing, he's got to learn the rules. To start, he needs just two things: money and a stockbroker. Both are relatively easy to come by these days, but he's not likely to keep either without a third, more elusive prerequisite: knowledge. Scraping up money and locating a stockbroker will be considered further on; but since stock-market knowledge is surely the most important and difficult of the three, this will be considered first.

The stock market is actually not one market but many. In the U. S., three predominate: the New York Stock Exchange (often called the big board); the American Stock Exchange, which tradition-minded Wall Streeters like to call the curb, because years ago its operations were conducted on the curb of a sidewalk; and the vast and important over-the-counter market, which is not really a single market at all but a collection of stock dealers scattered across the country. Shares in most major U. S. corporations are bought and sold (traded, in Wall Street jargon) on the New York Stock Exchange; their younger and more speculative competitors show up on the curb; and most of the rest, comprising tens of thousands of companies, large and small, are found over the counter. Besides the three major exchanges, there are at least 15 others, the most important being the handful of markets serving Detroit, Boston, Pittsburgh, Baltimore, Chicago, San Francisco and their respective environs. These smaller exchanges feature stocks whose appeal is regional, rather than national; but they also deal in some shares that are sold on the larger exchanges. In addition, a feisty and relatively new outfit called the National Stock Exchange, also located in New York, is trying to establish a market in shares even more speculative than those sold on the curb.

Just as there are several types of stock market, so are there several types of stock. By far the most common is called just that--common stock. When investors talk about the vicissitudes of their stocks, 99 times out of 100, they mean common stocks. The holders of a company's common stock, in toto, are the owners of the company. They get to vote in the firm's affairs (one share, one vote) and they participate in the company's profits in a similar fashion. From its profits, the company might pay cash dividends--which means that the stockholder gets a check, usually quarterly--or it might retain its profits to finance new factories and otherwise expand its operation. In either case, if the company prospers, the share owner should, too. His dividends, of course, are immediately spendable, and the company's retained profits should increase the value of his shares, which means he should receive that much more when he sells.

The "shoulds" are necessary because often the share owner does not gain or lose in direct proportion to the fortunes of the company in which he owns shares. This is because the value of a share is set not by die issuing corporation but by the buyers and sellers who make up the market place. A share of stock, like everything else, is worth only what another person will pay for it. This is the challenge and the excitement of the stock market, and all the techniques of stock playing--there are as many techniques as players--ultimately rest on this premise: that when the time comes to sell, the investor will find someone who, for one reason or another, is willing to purchase his shares at a price higher than the investor originally paid for them. In other words, when all is said and done, stock-market success is largely a matter of mass psychology, with the investor trying to guess just what sort of stocks future buyers will be willing to pay more for.

He might guess successfully for any number of reasons. Perhaps he buys shares at a point in history when potential stock buyers are gloomy about the future of the economy. Such an attitude prevailed most strikingly in the spring of 1932, though it was repeated as recently as 1966 and again last year. If public fears prove unfounded, then the value of many shares will rise. More typically, the successful investment will involve an assessment not of the entire economy but of the fortunes of a particular firm. Such stocks may involve companies whose profits an investor correctly divines are about to rise markedly; they might also involve firms that he was right to feel stand to benefit from unexpected outbreaks of war or peace; those that he accurately guesses will profit from new discoveries; or those that, for any other reason, he presciently senses will seem more attractive to stock buyers at some point in the foreseeable future. Knowledge of the future is all that's required. But since the future is unknowable, knowledge of what's currently happening in business, in the economy and in the world is a workable substitute, as long as the investor never forgets that all the statistics in the Department of Labor or The Wall Street Journal can still prove ruinous unless he has an equally good knowledge of people; because it is people, not statistics, to whom he must ultimately sell his shares.

No matter to whom he sells, his chances of making a profit are good, even excellent. This would sound like a journalist's generalization if it weren't supported by hard fact. In a remarkable study conducted at the University of Chicago a few years ago, Professors Lawrence Fisher and James Lorie, aided by a huge computer, evaluated the performance of every common stock traded on the New York Stock Exchange between 1926 and 1965. The study embraced 1856 stocks and 57,000,000 possible transactions, representing every different big-board investment that could have been made, held or liquidated at the end of each month during the 39 years programmed. The results must have surprised even Merrill Lynch, Pierce, Fenner & Smith, the nation's largest brokerage firm, which financed the venture. Assuming reinvestment of dividends and subtracting brokerage fees at both ends of every transaction (an expense that most studies conveniently (continued on page 221)Stock Market(continued from page 130) ignore), the median return on a random common-stock investment turned out to be 9.3 percent a year. It didn't matter what stock was bought, when it was purchased nor how long it was held. All that mattered was that one invest often enough and at random; one was bound to end up making money at a rate of over nine percent a year. The study also revealed that 78 percent of all 57,000,000 transactions showed a profit, which theoretically means that an investor's chances of picking a winning stock, blindfolded, from an outspread Wall Street Journal are something close to eight in ten.

The methodology of the study is open to criticism, but the results are probably representative. Not surprisingly, they caused great jubilation in the stockbroker community, though the mutual-fund industry, which by and large had been achieving lower-than-random results, was less pleased. (Despite recent setbacks, the funds are now doing better, and readers inclined toward this less-demanding form of investment are referred to Playboy's Guide to Mutual Funds, by this writer, published in these pages in June 1969.) Even subtracting income taxes, the Fisher and Lorie figures were still remarkable. The after-tax return for an individual with a taxable income of $10,000 (based on 1960 dollars and tax rates) was 8.7 percent; for an individual in the $50,000 bracket, 7.7 percent.

Relying on this information alone, tyro investors in every tax bracket might do well to confine their initial transactions to common stocks listed on the big board, where the deck seems provably stacked in their favor. This would lessen the preparatory study involved, eliminating the need to brush up on preferred stocks, bonds, convertible bonds, rights, warrants, puts, calls, straddles and all the other investment arcana, discussed further on, in which investors can also make or lose money. Presumably, the investor would hope to achieve a return considerably higher than the random rate, if only because he could nail down a risk-free ten percent these days just buying bonds. But even if the investor concentrates his early efforts on common stocks alone, his choice is far from limited. To the 1200-plus common stocks listed on the big board should be added a like number on the Amex and perhaps another 1000 of the better-known over-the-counter offerings. Clearly, the investor faces more choices than he can possibly grapple with, and some way has to be found to reduce them to manageable proportions.

The easiest way is to begin by exploring not the vast universe of possible common-stock investments but the smaller and more negotiable universe of the investor's own experience. Almost all of us, if we thought about it long enough, could unearth an attractive stock from the personal world with which we're familiar. Perhaps it's the firm we work for, if we can confirm from personal knowledge that it's well managed and making fatter profits year after year. Or perhaps it's the competitor that always gives us so much trouble, that supplier who always exceeds quality standards, that hot-shot firm a fast-rising friend works for or a corporation that regularly produces new products we can't do without. Was anyone unimpressed with the first Polaroid camera he saw? A purchase of Polaroid stock, at any time up to 1965, would now have increased at least fourfold. That's almost 100 percent a year.

Unfortunately, the more a novice learns about the stock market, the less he'll be willing to rely on his own judgment. Once he begins reading The Wall Street Journal every morning, once he starts poring through the business and investment magazines, subscribing to an advisory service or two, hanging out in the brokerage board room, watching stock figures shoot across the wall and listening to what the traders are whispering about, shuffling through the volumes of financial data that supposedly enable him to make better investment decisions; once he has immersed himself in all this, how can he bring himself to buy a stock like Polaroid just because he owns and enjoys one of the company's cameras? The message should be clear: Never assume that anyone knows more about the market than you do. The stock market, like the future, cannot be predicted. People who make correct forecasts are not oracular--just lucky. Your guess has to be as good as the next man's. For you, it's probably better, because it's personally suited to your own needs--psychological as well as financial. As will be seen, this is crucially important.

Yet, certain facts can help the would-be investor act intelligently. For instance, he ought to be able to interpret the stock-price figures in the daily newspapers. This is an especially useful point of departure. Not only is the information cheap and readily available but, since newspaper stock quotations consist solely of names and numbers, no one will be ruined by just reading them (as can result from a serious flirtation with a bad how-I-made-a-million-in-stocks book).

Whatever paper he reads, the investor will find that the daily quotations of the listed stocks look something like this:

119 65-1/4 StdOilOh 2.70 679 119 110-7/8 117-1/4 119-7/8+43/8

A cursory reading should reveal that the stock in question is Standard Oil Company of Ohio, which happens to be one of the shares that bucked the trend in last summer's market blowout. The first two figures--119 and 65-1/4--are the highest and lowest prices at which the stock has sold during the year. (U. S. stock prices are invariably quoted in dollars and fractions of dollars, rather than in dollars and cents; and over the years, investors have come to think that way themselves, because it makes calculations easier. Typically, dollar signs are dropped for brevity, so $65.25 becomes 65 1/4; then, to save breath and provide the proper aura of detachment, dollars become "points," so that an increase of $2.50 is "up two and a half points.") The year's high and low figures are quite instructive, but, for some reason, only the better financial pages see fit to include them.

The figure following the company name represents the dividend the stock paid last year--in this case, $2.70 a share. Companies that regularly pay dividends other than cash, usually in the form of stock, are indicated by a lower-case letter after the dividend figure. An alphabet soup of other symbols carries additional significance; but, since each wire service has its own symbology and since many newspapers deviate even from these, the investor would do well to consult the explanatory table that usually accompanies the quotations. The number following the dividend figure represents the day's trading volume in hundreds of shares; in other words, 67,900 shares of Sohio were traded that day. If the investor has been watching the stock closely, he might recognize that this figure indicates quite a bit of trading action. Typically, fewer than 25,000 Sohio shares change hands daily.

The next figures describe the day's price movement--opening price, high price, low price and closing price--and the final figure reveals that in the last transaction before the market closed, the stock was selling at a price of $4.38 higher than that of the closing trade the previous day. (Many investors mistakenly think that the last figure, +43/8 in this example, tells how much the stock went up that day. Actually, the change during the day is the difference between the opening price and the closing price--which, in this instance, were 119 and 1197/8, giving a daily change of 7/8 of a dollar, 88 cents.)

The point of all this is to show that one small row of figures conceals a gold mine of useful information. It not only enables the investor to make a stab at charting the day's action in Sohio but it also hides clues to the direction in which the stock is heading. Needless to say, the clues are ambiguous. In this case, since the closing price of $119.88 represents an advance of $4.38 beyond the previous day's close, the stock must have closed the previous day at $115.50. Then it opened the next day at $119, for an overnight jump of $3.50. Such a large opening gap is unusual. Either the market for Sohio is unstable or some new development has taken place overnight. (In this instance, both explanations apply.) The amateur investor might regard such action as ominous. Since the stock jumped sharply overnight and closed at its highest level of the year (actually, its highest level ever), he could well conclude that the stock is overpriced and should be sold. A more seasoned investor might reach the opposite conclusion. Stocks that reach new highs tend to keep reaching new highs. So, on the basis of the same information, while the amateur is selling, the seasoned investor might be buying. Meanwhile, the professional investor could reach yet a third conclusion. The stock opened strong on a new high, but after the large initial leap, it didn't forge much higher. Whatever pushed it up an opening $3.50 wasn't sufficient to move it one more dollar the entire day. So, despite the record high price, failure of the day's action to confirm the strength of the overnight upward move could indicate to the pro that the stock might not be likely to go up much farther. At the very least, the signals are confusing, so the pro would probably leave the stock alone.

In this case, he would have made the right decision; for, after reaching its new high of 1197/8, Sohio immediately dropped back to 110 and, a few weeks later, was selling in the low 90s. Our hypothetical amateur investor, acting for the wrong reasons, would have won; his more seasoned counterpart, acting for the right reasons but not examining the situation closely enough, would have lost; and the truly sophisticated investor, unwilling to risk his money in a dubious situation, would still have all his capital available for a more promising prospect. Quite often, this is just what happens.

While virtually all daily newspapers publish stock quotations, their investment usefulness beyond that is limited. For more substantial business news and investment information, two papers predominate: The New York Times, offering far-above-average financial coverage, and The Wall Street Journal, the vade mecum of the investing public. Barron's, a tabloid weekly published every Saturday, runs a most comprehensive compilation of stock statistics, including dividend dates and past and current figures on corporate profits--something no other newsstand publication offers. Besides its wealth of statistics, Barron's features perceptive articles on market analysis. A handful of biweekly or monthly magazines also cater to the needs of would-be or current investors, but they are almost uniformly dreary and suffer from a grievous conceptual flaw: the assumption that anyone who is interested in the stock market is also interested in business and businessmen. If an enterprising publisher were to produce a magazine edited not for businessmen but for investors, a magazine that talked about stocks instead of machines and interviewed speculators instead of executives, he would probably make a fortune. Until he comes along, investors must make do with what's available. Forbes deserves special mention, if only because it is so much better than its competitors. Fortune, unabashedly edited for well-off businessmen, also publishes useful investment information.

A horde of stock-market advisory services, at last count, 2675 of them, fill the void left by the business and investment magazines with weekly newsletters telling investors when and what to buy and sell. Since anyone with a typewriter and a duplicating machine can get into the advisory business, it's not surprising that the value of most such advice is marginal. In the aggregate, the performance of the advisors' recommended stocks seems just slightly lower than the performance of stocks in general. Though this is quite a feat, it hardly justifies the price of a subscription, which can run as high as $200 a year--tax deductible. Back in the Depression, delighted Congressional investigators unearthed a stock-market advisor who had achieved an enviable track record (and an income of $40,000 a year) by picking stocks on the basis of an interpretation of the Jiggs and Maggie comic strip in his Sunday paper. Equally bizarre methodologies probably persist today; but by and large, the advisors are rational even when they're wrong, which is frequent. To be sure, some of them have been in business for decades, so they must have something worth saying. The better ones should be willing to provide a complete record of their past recommendations, so that the would-be subscriber could reasonably assess the value of their advice. And the best of the lot are probably those that provide hard facts on which the investor can base his own decisions. Most advisory services offer free copies or a reduced-rate trial subscription, so the patient investor may find one that suits his needs.

Whether he purchases advice or conjures up his own, the stock dabbler will soon learn that the process by which investors decide to buy or sell stocks is far from scientific. Despite its name--security analysis--stock guessing hinges heavily on the psychological make-up of the person doing the guessing. For purposes of description, the techniques divide into two broad groups: fundamental analysis and technical analysis. Fundamental analysis, the older and more established of the two, rests on the reasonable assumption that there is some relationship between the fortunes of a firm and the price of its stock. The fundamental stock watcher will try to sift through all the relevant information by which a company's present and future performance can be measured. This might include the firm's current rate of profit and growth, its past performance, its competitive position within its industry, the state of the economy, the firm's marketing capabilities, prospective new developments and all the other statistical insights that might be drawn from a balance sheet, a profit-and-loss statement, a corporate prospectus or a quarterly report. Fundamentalists will spend hours sifting through these and other documents, jotting down figures, comparing past performance, evaluating management strength and computing net asset values and earnings ratios. (Corporate profits are rarely called profits; earnings sounds less crass.) The fundamentalist feels that the more he understands about a company, the better is his basis for assessing its potential and, thus, guessing how its stock will fare.

The fundamental approach is essentially a conservative one. Whether or not he realizes it, the fundamentalist is looking for investments that offer exceptional margins of safety. He seeks stocks that seem palpably more valuable than their current selling price, either because they promise dividends far above the prevailing interest rates or--more likely nowadays--because they promise growth through above-average earnings.

The advantage of investing on the basis of fundamentals is that once the fundamentalist has done his research, he needn't make the effort (it can easily become agony) to watch day-to-day price movements and day-to-day developments. Fundamental analysis locates long-term trends. If his analysis is sound, the fundamentalist can just sit it out--assuming he has the proper reserves of self-mastery and money. (Often, his patience runs out first; he sits on what he deems a promising stock for 18 months and watches it go nowhere. The week after he abandons it, the stock skyrockets.) At worst--if he has chosen the right stock and keeps his cool--he shouldn't lose very much.

But there are psychological difficulties. Fundamentalists will agree that almost every company can provide them with more statistical information than they can properly cope with. Yet few agree on which fundamentals are most relevant and, even if they get past this hurdle, on just what these relevant fundamentals mean. A bull (who thinks stocks will go up) and a bear (his opposite number) can pore over the same data and reach contradictory conclusions. And in the unlikely event that they agree, the market won't necessarily follow, because, to repeat, stock prices are determined not by statistics but by people. A stock's fundamentals can look unarguable, but if would-be buyers don't like the company's industry, its long-range potential or even its name, the stock will just lie there. Years ago, a company called Seaboard Airlines invariably rose and fell with the airline stocks, even though its full name was Seaboard Airline Railroad and it was just that--a railroad; and recently, bemused investors watched Southern Gulf Utilities transmogrify overnight into Ecological Sciences Corporation. Of course, strict fundamentalists would deny the importance of such unquantifiable press-agentry. If they can find stocks whose fundamentals make them seem relatively cheap, they are content, because they believe that sooner or later, the market will recognize true value and their toil will be richly rewarded.

One of the most consistently successful devotees of fundamental analysis is Fred Carr, who was in charge of the investing policies of Enterprise Fund during the recent years when that mutual fund outperformed all others. Carr is well known as an early and heavy investor in Kentucky Fried Chicken, which became one of the fastest-rising common stocks of the late Sixties. Remarkably enough, Carr's initial commitment in Kentucky Fried was based solely on a reading of the company's prospectus, a document that was available to anyone who cared to send away for it. His technique was elegantly simple: He figured out how much profit could be expected from each chicken outlet (in the fast-food-to-go business, this figure is very consistent) and multiplied it by the number of outlets the firm planned to open during the next two years. The resulting profit figure indicated to Carr that the shares were selling at a low price, compared with the finger-lickin' earnings that could be expected in 24 months' time; so he bought. The shares, which first sold at $15, recently had a market value over $300 each.

The devotees of technical analysis, called technicians or chartists, try to avoid the fundamentals. They believe that all the factors that can affect a stock's price are already reflected in the price, so the best way to locate the trend is to study the price movement itself, usually through charts. Many technicians keep their own charts, laboriously filling them in each evening or each weekend; but for those unwilling to compromise their time even to this extent, scores of technical services offer ready-to-use charts, for one stock or for thousands, airmailed to the subscriber every Friday night. If the technician reads his charts correctly, the market--which chart theory says already reflects the relevant fundamentals--will tell him what to do.

But the technician also faces psychological pitfalls. As with fundamental analysis, different temperaments can interpret identical charts differently; and even when they agree, the market can still drift off perversely in the opposite direction. But unlike the fundamentalist, the technician must keep a close eye on minor fluctuations; and unless he has both the time and the stamina to withstand the daily or even hourly crises that this sort of eyeballing entails, he may come to grief. Beyond this, stock charts by their very nature describe only the past. Especially in an area as fickle and as future-oriented as the stock market, one can surely question how relevant past performance is to future performance.

But technical analysis also has some undeniable attractions. Not only does it avoid the ordeal of leafing through such weighty tomes as Moody's Industrial Manual but it also offers an investment technique that requires a minimum of economic expertise. The true technical analyst doesn't want his mind violated by a single fundamental. He reasons that any tidbit of tangible news he hears might prejudice his reading of the charts, which he feels already reflect all the news, giving just the proper weight to each development. In extremis, the technician would prefer to plot price movements without knowing what the price is or even what stock he's following. A West Coast stockbroker has actually succeeded at this. His advisory service sends him charts from which both the name and the price of the stock have been obliterated. After he selects the charts that seem most promising, he calls the service to find out what they represent. He's been doing this for years and, at last report, he was still active and prospering.

No matter what you may think of such a technique, trading by the charts is far from an occult science; a good deal of common sense supports it. The illustration (right) shows a technician's picture of Northwestern Steel & Wire Corporation, a big-board stock that traded in a well-defined range last spring and summer. As is typical with such charts, the vertical dashes indicate the week's trading range and the horizontal ticks show the closing prices. Between March and August, as the chart shows quite clearly, the stock never closed above 51 nor below 44. Common sense suggests there must be a reason for such constricted performance over six months. The simplest explanation is that some unknowable investors (perhaps the same people) were willing to buy all shares offered whenever the price went down to 44 and to sell without limit when the price got over 50. For anyone with sufficient capital, this can be a highly profitable activity. But once a stock has established this sort of trading range--here the technicians would call it a rectangular formation--it can be expected to move sharply if the price breaks out on either side. In early September, when the stock finally closed above 51, technicians would have rightly assumed that N. S. & W. had given a buy signal. Whoever was doing all that selling around 50 was obviously no longer in the market and technicians could expect the stock to rise, perhaps to a much higher level. The presumptive explanation is that all prospective buyers and sellers have finally been cleaned out of the trading range, so the stock must move on up to a new equilibrium. In this particular case, N. S. & W. ran right off the chart after its breakout. In October, it was selling in the mid-80s.

A host of other chart formations, variously described as flags, pennants, heads-and-shoulders, triangles, islands, saucers, etc., are similarly reliable--or, when they give false signals, similarly misleading. Many defy common-sense interpretation, which would make their use questionable, if only they didn't seem to work fairly often in predicting price trends. One reason for their performance might be that chart trading is now quite popular; tens of thousands of technicians are buying and selling stocks every day. Right or wrong, they are staking hard cash on their calculations, and by their very number they can frequently make a stock conform to their notions of what it should do. Unfortunately, the more they rely on the same signals, the less well any of them should profit. Nevertheless, some large investors--notably mutual-fund portfolio managers--even though they may think chart trading is so much numerological gobbledygook, still follow charts religiously, just to get a feeling of what the chart traders are up to.

What most recommends chart investing is that it automatically limits losses. When the technician makes a mistake, it costs him relatively little; when the fundamentalist makes a mistake, it can cost him everything. The technician ponders his charts and determines that if a stock penetrates above $58 a share, it should rise to $70 or so. He buys automatically at the proper moment, and if the stock doesn't immediately conform to his expectations--in other words, if it drops instead of rising--he must sell. He was simply wrong, and he knows it at once. He takes his loss and goes back to the graph paper. Needless to say, chart trading will produce a number of such mistakes, even a disturbing number. But they will be small mistakes. If the technician can limit each loss to five percent or so, he can be wrong four times out of five and still make a profit. If he is right half the time, his profits will be substantial. In other words, the technician enjoys the luxury of being permitted many mistakes.

Though the fundamentalist will make fewer mistakes, the errors he does make will tend to be whoppers; so he can't afford as many. This is due to the difficulties he encounters in limiting his losses. He buys the same stock as the technician at $58 a share, not because its chart looks good but because he thinks it's underpriced. Again, underpriced or not, the stock begins to drop--all the way down to $48. Whereas the technician would get out immediately, the fundamentalist can only return to his analysis, to see if he miscalculated. If he can't find any errors, the stock has to be a better buy at $48 than it was at $58; so he should probably purchase more. But if the stock then keeps going down--and many do--the fundamentalist will soon find himself in an impossible situation, "averaging down" to take advantage of bargain prices but, in the process, buying ever-larger chunks of an ever-deteriorating stock. Like the red or black roulette player who doubles up after every loss, he may find himself risking thousands to recoup a small bet. At his worst, the diehard fundamentalist in a losing stock resembles Nietzsche's madman, pleading the sanity of a stock he knows is worth $100 in a market place of idiots who won't offer $15 a share.

Many investors are unaware that the most cherished barometer of common-stock performance, the Dow-Jones Industrial Average, was developed as a technical tool. The D. J. I. A., recording the combined action of 30 blue-chip industrial stocks on the big board, was the invention of Charles Dow, father of Dow-Jones and Company and grandfather of technical analysis. Dow evolved what is now known as the Dow theory, the oldest and most respected technical device for predicting stock-market sea changes. The D. J. I. A.'s usefulness is far more than technical; it has become the popular figure for describing over-all market performance. Even though loaded with conservative stocks that are currently out of favor with the Wall Street cognoscenti, it's fairly accurate, because the 30 indexed stocks account for much more dollar volume than their modest number would indicate. The average has often been used as a historical index of stock-market performance; but this can be somewhat misleading, since the figure has undergone numerous face liftings since Dow contrived it around the turn of the century. Curiously enough, only one company listed in the average, General Electric, was a part of the figure when it was devised, and even G. E, was omitted for a while. Another dropout was IBM, which was discarded. Had it stayed in, it would have pushed the D. J. I. A. about twice as high as it is. Besides the D. J. I. A., a half dozen other stock indexes provide similar information and lend themselves to similar criticism. Since all market averages are just that--averages--they provide a fix on what stocks in general are doing, but they have little to tell the individual investor, who must buy stocks in particular.

Somewhere between the chartist and the fundamentalist lie those investors who use what are called mechanical trading rules. These are no more than formulas that supposedly predict the direction in which stocks (i.e., stocks in general) will move. One of the earliest of these formulas, cited by Benjamin Graham in his Security Analysis, was a theory developed by Colonel Leonard P. Ayres of the Cleveland Trust Company in the Twenties. Ayres concluded that stocks should be purchased when the number of operating blast furnaces in America rises above 60 percent; and bonds should be unloaded 14 months after a low point in pig-iron production. This sort of theorizing may seem vaguely plausible when it is set forth, but only because it worked in the past. A future test is needed to ascertain its real usefulness. In this case, blast furnaces haven't operated below 60 percent (except during strikes) in modern memory and pig iron nowadays is nothing more than an anti-establishment euphemism for handcuffs.

In practice, all such efforts to develop a sure-fire formula to beat the market have been doomed to failure. The psychological barriers have seen to this. One man's successful system can be--and often has been--another man's ruin. Moreover, unbeatable formulas embody an economic paradox: Given an infallible system to predict stock-price movements, sooner or later everyone would begin using it, and everyone can't win. Yet the search goes on. An enterprising New Yorker has developed an elaborate theory correlating stock prices with the length of women's skirts. His general rule--don't sell until you see the whites of their thighs--may have called the market top last year. And a computer, fed reams of statistical data about the top-performing stocks of the Sixties, advised its eager programmers to buy only those stocks whose names end in X. An even more recent discovery, the over-the-counter volume index, now tabulated by Barron's, has a contemporary history of accurately signaling market tops. The assumption is that whenever over-the-counter stocks are excessively popular, weak speculators dominate the market and a decline can be expected. But it should be obvious that any stock-market technique, whether fundamental, technical or mechanical, should be regarded with suspicion if it doesn't have a basis in common sense.

Sad to say, many investors--perhaps the majority--enter the market with no technique at all. They buy one stock on a friend's tip, another because they saw it touted in a newspaper column, a third because their broker says its chart looks good and a fourth because they've heard it's going to split. They might even make money with this mindless approach; after all, the odds are loaded in their favor. But without a single technique applied consistently, they cannot expect consistent results. Rather than investing, they are gambling. The man with one technique, consistently applied, gets feedback. He will either profit consistently or lose consistently. If he loses, he at least knows his technique is faulty, so he can amend it. And when emendations finally produce what for him is a winning technique, he can expect it to win for him with some regularity.

When the would-be investor finds a technique he thinks will work, he can check out its soundness by making paper transactions--pretending he's investing without really doing so and keeping track of the results as the months go by. Whatever valuable knowledge he comes by this way won't cost him a cent. Of course, it won't make him a cent, either; and, in a way, all the paper transactions in the world aren't nearly as instructive as one real investment, whether it turns out good or bad. It's astonishing how much you'll learn about the stock market once you have a few thousand dollars riding in it. Corporate reports, obscure chart formations, offbeat investment publications, all the detritus of die investment world will suddenly take on an almost cosmic significance when hard cash is on the line. Going in cold is certainly the easiest way to learn about stocks, but it's not the most profitable, because you should do your homework before you enter the market, not afterward. Old-timers insist that real experience is the only teacher, meaning that you've got to lose money before you gain the right to earn some (with the implicit assumption that they expect you to lose money to them). But no matter to whom you might lose money, you learn nothing from losing except how to lose. Losing may teach you what not to do, but it doesn't teach what you ought to do. The way to learn to win is by winning, which you're not likely to do unless you learn the rules before trying to play the game. Among other things, this requires a stockbroker.

Finding a broker isn't a big problem. In fact, if while experimenting with the market you have succumbed to ads offering free copies of brokerage-house stock-research reports, you can be certain that brokers are already on your trail. Most of the major brokerage houses greatly expanded their staffs during the high-volume market that ended abruptly early last year. A few novices have been let go since then, but board rooms are still teeming with hungry young customer's men of great vision and small clientele. For the first time in years, it's a buyer's market for stockbrokers, and it's probable that from among the glut the would-be investor can find a good one. Good or bad, he should work for a firm with a membership in (or connection with) the major exchanges. All large brokerage houses, and most of the smaller ones, qualify.

There are two breeds of broker: the good and the glib. The good broker is a savvy investor in his own right. Perhaps he doesn't have the money right now (hot-shot young brokers, despite all their publicity, aren't paid nearly as well as most investors imagine). Perhaps his personal situation prevents him from taking the risks implicit in any stock-market transaction. Or perhaps he does have the money and is taking the risks, quietly building up a fortune toward that distant day when he can tell both clients and employer to go straight to hell, he doesn't need them anymore. Whatever his situation, such a man, while he remains a broker, will try to put his customers only into situations he believes in himself. He realizes that his best interest is his customer's best interest. He strives to build his clients' fortunes, because he knows that rich clients generate fat commissions, and fat commissions mean more money to enhance his own fortune. Obviously, good brokers are hard to find. Like good running backs, they fatten too quickly. Why get beat up every Sunday, if you own a chain of restaurants, a high-rise or three or a liquor distributorship?

Glib brokers are more common. These are men who have small investment sense themselves but who are so good at persuading others of their expertise that they can prosper, like wood ticks, from the constant procession of new hosts with which their peculiar talent provides them. For the investor who can make his own decisions, it really doesn't matter which breed of broker he deals with. All that matters is that his broker follow orders. Actually, the glib variety, properly groomed, is superior at this, because he'll endorse any investment, however irrational, as long as it provides him a commission; whereas the good broker will obdurately and conscientiously oppose a new idea, no matter how perceptive, if it runs against the grain of his own investment sensibility, which is enormous.

The investor in need of stock-market advice must find a good broker. This is an especially difficult task, because the good broker, his truncated life expectancy notwithstanding, should have experience in down markets as well as up. Joseph Conrad once observed: "Any fool can carry on, but only a wise man knows how to shorten sail." In stock-market terms: An idiot can look like a prophet in a roaring bull market; it's the bear markets that try an advisor's mettle. The investor who must rely on his broker really has no choice but to find a man on whom others have relied successfully. He can ask his friends, his lawyer, his banker, even his doctor. Strangely, doctors are an especially good source; they have lots of money, invest heavily, hear from brokers frequently and seem to enjoy talking about stocks.

For the same reason that General Motors executives drive Cadillacs rather than Lincolns, brokers usually endorse the stock recommendations that are periodically emitted by the firms for which they work. But this doesn't mean their customers should follow suit. Brokerage-house research departments are set up to accommodate big clients who generate big commissions. This includes mutual funds, pension funds, trusts, banks and insurance companies. By the time a brokerage-house report trickles down to the small investor, the big boys have already acted on it (assuming it's worth acting on) and may be girding themselves to sell. Investors who read the financial papers have been recently treated to an orgy of self-criticism, from the heads of the two biggest stock exchanges, directed at the quality of research that reaches the small investor. No matter that all this flagellation prefaces a big boost in small-transaction commission rates (as the president of the New York Stock Exchange engagingly put it: Stiffer commissions will provide "an incentive to provide more emphasis and depth in services to the small customer"), because the point should be clear: Free advice, no matter what its source, is worth just what you pay for it--nothing.

Like bartenders and barbers, stockbrokers have finely tuned instincts for their customers' psychological needs. Depending on the client, they can be expected to disgorge a computerlike print-out of unsolicited information or to perform their assigned chores in discreet and competent silence. The novice investor with more money than ideas can expect sufficient tips from his broker to keep him active through retirement or bankruptcy. And the investor who merely wants his orders executed promptly and accurately can find similar satisfaction, probably from the same man. It is the customer himself, through the signals he sends to his broker, who will determine the treatment he gets.

Besides executing orders, brokers are willing (even eager) to offer loans, in the form of money, if customers want to buy stock on margin, or in the form of shares, if the customers want to sell short. Both concepts are subject to popular confusion. Margin is the percentage of the cash value of a transaction that the customer must put up if his broker is to lend him the rest. Currently, the margin--set by the Federal Reserve Board--is 80 percent. The investor who wants to buy stock selling at $5000 must bring at least $4000 to the transaction. His broker will then lend him the remaining $1000--at interest, of course--retaining the purchased shares as collateral. Before the great crash of 1929, margin rates were down to ten percent (even lower for favored customers) and money was easily borrowed. At today's high interest rates, the brokerage house might charge 10 or even 15 percent on the skimpy 20 percent that it can lend. In recent years, the margin rate has dipped as low as 50 percent and the interest rate on broker loans has gone as low as 5; should these happy conditions once more prevail, small investors would do well to margin themselves to the hilt, to profit from the increased leverage that accrues from working with borrowed money. But unless the investor is dealing in five- or six-figure sums, interest rates are so high--and borrowable funds so scarce--that margin transactions are barely worth the effort. Banks will make collateral loans against stock certificates--as long as you swear you don't intend to use the loan to buy more stock--and Canadian banks don't even require a loyalty oath. But wherever you go, the interest rate will be quite dear, so that these quasi-legal shenanigans are better postponed to days of easier money.

Short selling, however, deserves more serious consideration. From the earliest days of stock transactions, action-hungry speculators have been eager to profit not only when a stock moves up but when it declines. This is done by borrowing shares from someone who already owns them, then selling the shares in the market. Subsequently, if the price declines, the short seller can repurchase them at a lower price, return them to their owner, and pocket the difference. Borrowing shares to sell short is usually no problem, because brokerage houses are literally awash with stock certificates, posted as margin collateral or otherwise held on customers' behalf. (Many investors--especially short-term speculators--rarely see a certificate, preferring instead to let their broker provide safekeeping.)

Because stock prices usually fall a lot more quickly than they rise, short selling, properly timed, can be much more lucrative than outright investing. But it's also more difficult and fraught with unpleasant philosophical overtones. To buy a share in American industry is a respected and eminently justifiable pursuit. Here the investor is betting on progress and stands to prosper with the fortunes of the economy and of his firm. If he's right, everyone wins. But by selling short, the investor is betting on disaster. He stands to prosper only if his firm--or the economy in general--deteriorates. For this reason, a great many small investors view short selling as something close to un-American and refuse to have anything to do with it. Only one small-investor transaction in 140 is a short sale.

The ideological case against short selling is provably unsound, but the short seller does face real difficulties that the ordinary investor never encounters. If the amateur buys 100 shares of stock at $20 a share, he knows in advance just how much he can lose. His prospective profits are limitless (the stock might go to $1000 a share), but he can never lose more than the $2000 with which he began. But with a short sale, the potentials are reversed. The best a short seller can do is double his money (if the stock he sells drops to zero), but there is no limit to the amount he can lose. If he shorts a stock at $20 and then it goes to $40, he'll lose his $2000. But what if it goes on up to $80, or to $500, or to whatever level might cost him more than he has? This is a remote possibility, virtually an impossibility; stocks just don't shoot from $20 to $500; and even if they did, shell-shocked shorts would find room to bail out along the way. But to the small investor, especially if he is the sort who balances his checkbook every month, the prospect of limitless loss, no matter how remote, is not worth facing.

A highly sophisticated computer study of short selling, recently published in the Financial Analysts Journal, confirms that such large losses rarely--if ever--occur. Instead, the study found, short selling consistently produces small losses, at a random rate of 8-10 percent a year, a figure that seems to verily the Fisher and Lorie studies discussed earlier. But who needs small losses, especially consistent small losses?

Beyond this, both the Internal Revenue Service and the Securities and Exchange Commission view short selling less than cordially. Even if an investor should stay short on the same stock for a generation, the IRS denies him the tax shelter of long-term capital gains (profits from investments held over six months and taxed at half the ordinary rate or 25 percent, whichever is less). Profit from every short sale is taxable as current income. For its part, the SEC insists that short sales be made on what is called an uptick--which means that you can sell a stock short only when it's rising. To top it off, the short seller must make good--to his broker and ultimately to whoever lent the shares--any dividends that might be paid on the stock he has shorted.

Whether the investor is a buyer or a seller, the sort of instructions that he gives his broker will depend on his investment technique. If he's like most smallish investors, eying a stock that he hopes will go up, he'll probably just ask his broker to buy it. This is really a request to buy "at the market," wherein the broker purchases the number of shares ordered at the best price he can get. The liquidity of the big exchanges is good assurance that such orders--in the quantities in which the small investor will deal--won't be filled at a price differing drastically from die last recorded transaction.

While market orders are by far the most common, there's nothing to prevent an investor from setting his own price, except that if it's very far from the current price, his order won't be filled. If he does name his own price, he's making what is called a limited order, which, not surprisingly, is any instruction that has strings attached. By far the most common limited order is known as a stop, because its most frequent use is to prevent losses. A stop is an order to buy or sell at the prevailing market price, after the stock has touched a level the investor specifies. In other words, a stop order automatically becomes a market order when the stop level is touched.

Stops are especially useful to technically oriented investors. In the example of Northwestern Steel & Wire, whose chart is shown on page 225, the technician, once he had perceived the boundaries of the emerging rectangular formation (this was clear by July), could have placed two stop orders: a stop-buy order at, say, 51-1/2 and a stop-sell order at 43-1/2. Thereafter, if he were supremely confident of his technical expertise, he wouldn't even bother to watch the stock's price, knowing that the market itself would trigger his purchase (or short sale) at the appropriate time. He has no certainty, of course, that his buy order will actually be executed at the stop price of 51-1/2 he might actually buy at 52 or 52-1/2. But since any penetration to 51-1/2 is a signal for him to act, he doesn't really care at what price his market order is filled, as long as it's filled right after the 51-1/2 level has been touched. In the example shown, this finally would have happened in early September.

Stops are also used, by technicians and fundamentalists alike, to protect profits. To continue the previous example, once the investor has purchased Northwestern Steel & Wire in the low 50s and watched with delight as it ran up delight the 60s in less than a week, he might begin wondering when to take his profits and go elsewhere. To avoid cashing in prematurely, he could put out a stop-sell order a few points below the previous week's closing price. Then, if the stock retreated back to his stop level, he would automatically be sold out. Once again, the market would be telling him what to do. And if the stock continued to advance, he could keep trailing his stop behind it, changing the stop level week by week, accumulating larger and larger profits until the stock finally reversed. (In this example, a stop trailing just two points below the previous week's closing price would not have triggered a sale until the stock reached the low 80s in late October.) Automatic orders like this are most easily placed in stocks listed on the two major exchanges, where specialists--brokers on the floor of the exchange who are charged with making the market in specific stock--skeep track of all outstanding orders above and below the market. But similar orders can also be set up, somewhat less effectively, for stocks traded over the counter.

There are many other types of limited order, all equally useful, and a good broker can probably comply with any order he can be made to understand. One that is not used as often as it should be is the MIT (market if touched) order, the opposite of a stop, requesting to sell a stock if it runs up to a specified level or to buy if the price runs down. MIT orders, favored by fundamentalists, are especially useful in getting in or out of a stock at a favorable price. The fundamentalist, with his eye on long-range values, can afford to wait for the market to come to him, rather than chasing it, as the technician so often does when his stops are triggered. Another common limited order is suggestively dubbed FOK (fill or kill)--also called a quickie. Here the investor sets his own price. If the order can't be filled immediately at that price, it is canceled. This device is used extensively in the commodities markets and is useful in buying or selling thinly traded over-the-counter stocks. But the investor would be laughed right out of the board room if he tried it in the popular stocks traded on the major exchanges. Limited orders are also circumscribed in time: good for one day, one week, one month or until canceled. As a courtesy, brokerage houses usually send out regular statements to customers, listing limited orders that remain unexecuted. Even the canniest investors are human, and these reminders obviate the costly possibility of forgetting to cancel an order.

Brokers, of course, are human, too, and the investor should never forget that they are essentially salesmen, paid in accordance with the volume of business they generate. Thus, they have a vested interest in action, while the prudent investor, like Hamlet, might have an equally strong interest in biding his time. In any case, brokers' recommendations are almost invariably recommendations to buy. Buy-oriented research is infinitely more useful to brokers. After all, almost anyone can be persuaded to buy a stock. To make money from a sell report, a broker has to track down someone who already owns the shares and convince him to unload. So be wary of advice from brokers. They may mean well, and many of them do, but their interests are not necessarily your interests. Depend on your broker to execute your orders faithfully and promptly, and be thankful that you don't have to pay him too much for this valuable service.

Compared with the commissions charged in most other investment media, broker commissions are really quite low. They are assessed on each transaction, which means each purchase or sale of a different stock. The commission rate is almost impossibly complex. Here's a sample--for stocks sold on the two big exchanges--in the range in which the reader is most likely to be dealing:

Cash Value of Shares Commission

$100-$ 399.99....... 2% + $3

$ 400-$2399.99....... 1% + $7

$2400-$4999.99....... 1/2 + $19

$5000 and up....... 1/10% + $39

All these charges are for round-lot transactions--those involving 100-share units. (Very infrequently, a round lot of an expensive stock might be less than 100 shares--usually 10.) Odd-lot transactions, involving fewer than 100 shares, are assessed at two dollars less than these rates, plus an odd-lot fee of either 12-1/2 cents or 25 cents a share. On the big board, the rate is 25 cents on shares over $55 and 12-1/2 cents on shares below; the break point on the American Exchange is $40. In addition to all this, there are substantial discounts for high rollers who trade in units of over 1000 shares; rates by negotiation in transactions under $100; special odd-lot fees for stocks that sell in units other than 100; small taxes and exchange fees that further add to the cost of each transaction; and a host of other tedious complexities. As a rule, it's not advisable to involve yourself in odd-lot purchases of stocks selling under $10-$15 a share, because the odd-lot fee, added to the broker commission, makes the price of admission relatively steep; and it's similarly unwise to invest less than $400 a shot, because on smaller purchases, the commission will be too high.

The biggest investment expense, however, is not usually brokerage commissions but taxes. But since the individual's rate of taxation can't be determined until the year is over, it's difficult if not impossible to estimate the tax consequences of a transaction when it's made. As mentioned before, short-term capital gains--profits from investments held under six months--are taxed the same as ordinary income. You add your short-term profits to your salary income and pay taxes on the lot. Long-term gains-- profits from investments held for more than six months--get preferential treatment, being taxed at half the ordinary rate or 25 percent, whichever is less. This means that while everyone has an incentive to make long-term capital gains, those in the over-50-percent brackets have even more incentive.

Unless you are infallible, you will probably incur losses as well as profits. When you pay your taxes, the law requires you to separate investment profits (or losses) into two bundles: long-term and short-term. Short-term losses are the most significant, because they can be used to reduce taxable income by as much as $1000 a year. They should also be the most common, because if you've followed the general principle of taking losses quickly and letting profits run (discussed below), you'll frequently conclude an investment year with long-term profit and short-term loss. You will have to pay taxes (at the more favorable rate) on the gains, but you can also use up to $1000 of the losses to reduce your income. For a bachelor in the 50 percent bracket, this represents a tax saving of $500, which makes the $1000 loss a lot more palatable. Losses over $1000 may be carried forward to future years, and a sizable "short-term tax-loss carry forward," as it is called, can be a surprisingly useful thing for a young man on the way up. It allows him to dabble in short-term speculations that (in tax terms) might otherwise be less attractive. And as long as it lasts, the short-term tax-loss carry forward allows him to reduce his taxable income, year after year, by $1000, a prospect that gets better and better as he moves into the higher brackets. Of course, it's still better not to have losses at all; but, as Bernard Baruch supposedly said, the only investors who never lose are liars.

In the Middle Ages, the well to do spent much of their time in search of the philosophers' stone--a device that would turn lead into gold. The 20th Century equivalent involves a quest for ways to transform short-term profits into long-term gains. Until a very few years ago, this could be accomplished with some consistency, but now the ever-watchful IRS has cracked down, so that, other than by holding an investment for the required six months, there is no alchemy to convert short-term profit into long term. But there are several ways to "freeze" a short-term profit and then push it forward into the next tax year or even push it forward indefinitely. Of course, the investor should have compelling reasons before he attempts to do this, and he would probably want to employ competent tax counsel to make sure nothing goes amiss.

A minor money-maker but one worth noting involves a quirk in the tax law--it might unkindly be called a loophole--that permits up to $100 in U. S. corporate dividends tax-free each year. Dividends over $100 are taxable as ordinary income, so the investor has smaller incentive to receive them. But every investor, especially those in the higher brackets, should set up his portfolio to yield that first $100 in dividend income. For the bachelor making $20,000 or so a year, this is equivalent to $200 in additional salary income; with returns as high as 12 percent currently available, an investment of as little as $800 can reward him with two or three nights on the town every year for the rest of his life. A small consideration, to be sure, but fortunes are built on small considerations.

Most of the highest dividend payers are not common stocks but preferred. Preferred stocks can be likened to interest-bearing corporate I. O. U. S. They are generally issued in peculiar situations, often acquisitions, where the corporation wants to raise money without issuing more common shares. (More common might alienate current stockholders by diluting the value of their holdings.) The company issuing preferred stock promises to pay a fixed annual dividend on each share, and it pledges to pay this dividend--no more, no less--as long as the stock is outstanding. (Dividends on common stock, of course, are not fixed; they rise and fall with the company's fortunes.) Preferred shares are so called because if the company is liquidated, preferred shareholders must get their money back before the common shareholders receive a penny. A preferred stock is thus similar to a bond, in that it promises only a fixed income. As with bonds, its market price tends to fluctuate not according to the prosperity of die issuing firm but according to the general interest rate.

An example should make this clear. When investors can get a seven percent return from U. S. Treasury notes, then the preferred stock of a first-rate company, just slightly less creditworthy than the U. S. Treasury itself, might sell in order to produce a dividend of eight percent. If the share's fixed dividend is $8 a year, then the share itself would have a market value of around $100, because the interest rate determines the price. If the return on Treasury notes should decline, say, to as low as three and a half percent a year, the preferred share might then sell to yield four percent. At this rate, a fixed income of $8 annually is worth not $100 but $200, and the happy man who bought the preferred share at $100 would have doubled his money. Unfortunately, in the past few years, interest rates have been rising, not falling, while rampant and persistent inflation has further undermined the putative security of a fixed income. Preferred shares have nosed steadily downward, to a point where investors are hardly willing to buy them. In fact, an investor these days might live a prosperous life without ever owning a single share. Preferred stocks--many of which trade on the New York Stock Exchange will be worth buying whenever inflation is brought under control and the interest rate starts turning down. Surely, this will happen sooner or later, but few investors would be willing to risk hard cash on their ability to guess just when.

From a corporation's standpoint, preferred stock is also unattractive because the company cannot deduct the dividends it pays to its preferred shareholders. The Internal Revenue Service insists that dividends--whether preferred or common--are not an ordinary and necessary expense of doing business. Interest, however, is a legitimately deductible expense, and in the past few years, corporations have increasingly raised money through interest-paying securities, which are called bonds. As noted, bonds are essentially similar to preferred stock. The company borrows from individuals and gives them a bond as security. The company promises to pay the bondholder a fixed annual interest (the going rate is now close to nine percent) and, after a number of years, to return his money. Since bonds, like preferred stock, represent only a fixed income, their market value also fluctuates inversely with the interest rate. In recent years, bonds have fared just as poorly as preferred stock. In fact, while the interest rate regularly reached new highs a while back, the bond market was just as regularly reaching new lows. The total amount of capital tied up in bonds amounts to some 300 billion dollars, and day after dreary day last summer and fall, every bond in the country was worth less than its purchaser had paid for it. The big-money investors, it seems, are not always right.

Many companies have circumvented the inhospitality of the bond market by issuing convertible bonds. These are ordinary bonds with a fillip: They can be converted into a fixed number of shares of the issuing company's common stock. The investor who buys convertible bonds has the security of a fixed income (though the return is lower than that on straight bonds) and he also has the chance to profit if the common stock into which the bond is convertible should rise. This article is not the place for a full discussion of the pitfalls and potentials of convertible bonds (or their near cousins, convertible preferred stocks), but a working knowledge of them is useful for anyone seriously interested in the stock market.

Common stock, preferred stock and convertible bonds all have one thing in common: They represent a tangible obligation on the part of the issuing company. In one way or another, the investor who purchases them has a stake in the firm's assets. But investors can also make (or lose) money in scraps of paper not backed by corporate assets. One example is a warrant, representing the right to buy a share of stock at a fixed price. The best-known warrants are sold on the American Stock Exchange, but the majority trade over the counter. Among the most popular warrants these days are those of Leasco Data Processing Equipment Corporation, a recently formed and highly successful computer-leasing conglomerate. Each Leasco warrant represents the right to purchase one share of Leasco common (from the Leasco treasury) at $34.80. At this writing, the common stock was selling for around $25 a share, so, technically, the warrant was worth less than nothing. Yet each warrant was selling for around $12. The reason for this is simple enough. If Leasco should quadruple in price (as it has been known to do), the holders of common shares would quadruple their money, but the owners of the warrants would fare even better, since, if the common sells at $100, the right to buy a share at $34.80 would be worth something over $65. In other words, while the common increases by a factor of four, the warrants would increase by a factor of six or more.

Warrants, since they represent the right to buy something, rather than the thing itself, are a breed of option. Options also take other forms. Rights are identical to warrants, except that they are much shorter-lived. Warrants may be good for years or even forever; rights are valid for a matter of weeks. Generally, a company will distribute rights to its shareholders when it's planning to issue more common stock. When exercised, rights permit the purchase of the new common shares at a small discount. As with warrants, the recipients of the rights can either sell them to someone else or exercise them.

Far more prevalent than rights are puts and calls. A put represents the right to sell such and such a stock at a set price for a given period of time and a call is its opposite: the right to buy. Virtually all puts and calls are for 100-share blocks; they are bought and sold through any stockbroker, though the investor can also go directly to dealers in New York. The time period varies from 30 days to one year, but the most popular run for 190 days, to give happy holders of profitable options the shelter of long-term capital gains.

The cost of a put or a call varies tremendously, according to the volatility of the stock, its price, the length of the option period and the vicissitudes of supply and demand. A 190-day call on 100 shares of a moderately volatile stock selling around $50 a share might cost $250 to $400. This is expensive, but for a speculator who has found a stock he thinks is due for a substantial and imminent rise, purchasing a call can be vastly more profitable than buying shares outright. For a stock selling at $50, for instance, an investor with $5000-plus could purchase 100 shares. But with that kind of money, he might pick up calls on 1200 shares. If the stock conformed to his expectations and six months later was selling at $75, he would make $2500 on the outright purchase, but $25,000 on the purchase of calls. Of course, if the stock had gone down or remained the same, the outright purchaser would lose relatively little, while the call buyer would give up his entire $5000.

Besides offering the prospect of limitless profits and limited or at least knowable losses, puts and calls can be used as insurance, to minimize investment risk. In fact, the investor can involve himself in near-limitless put-and-call combinations. A straddle is a put and a call in the same stock (useful when an investor thinks a stock is going to go but doesn't know which way); a strap is one put and two calls; and a strip, one call and two puts. The use of the last two is arcane and complex, generally combined with the outright purchase (or short sale) of a block of the same stock in the pursuit of both profit and tax advantage. Novices enter this realm of the put-and-call game only at their peril. And they should beware of becoming so fascinated with insuring stock profits that they wind up with what is known in the trade as a Mongolian hedge--an investment so well insured that both profit and loss are impossible, with the investor's capital gradually dissipating in insurance premiums.

In addition to all this, an investor with sufficient cash or a suitable portfolio of stocks can get into the option business from the back side, by selling (or "writing") puts or calls, rather than buying them. This is a lucrative pursuit, too specialized to discuss here, but interested parties might consult their broker about it or read Paul Sarnoff's Puts and Calls, available for $5.95 from the American Research Council, Box 183, Rye, New York 10580. Several impressive mathematical studies have shown that while big killings are undeniably made through buying these options, those who write them profit more consistently. This is no more surprising than observing that while you can win a fortune at roulette, you're better off owning the casino.

Once the investor has a grasp of the various elements that comprise the stock market, he can begin to put them to work. If he really craves action, for instance, there's nothing to prevent him from buying a call on a warrant--in essence, purchasing the right to buy the right to buy a stock. Given this sort of double leverage, even a small move in the stock at the end of the option chain can translate into enormous fluctuations in the value of the call. The warrants associated with Tri-Continental Corporation are a perennial favorite for this technique, because Tri-Continental is a diversified investment company, for all intents and purposes a mutual fund, whose price movement usually parallels that of the broad market averages. Popular feeling that stocks are about to turn is usually accompanied by heavy activity in Tri-Continental warrants.

Buying calls on warrants approaches the apogee of risk taking. Another two-sided technique, infinitely more conservative, is arbitrage. This involves the simultaneous purchase and sale of essentially similar securities, in hopes of profiting from small price discrepancies. A classic example would involve the purchase of 1000 shares of General Motors at $72 on the New York Exchange and its simultaneous short sale, in San Francisco, at $72.50. Here, the profits, after broker commissions, would be a lofty $38 and the investor would need a five-figure sum to set it up. Not surprisingly, most such transactions are conducted by brokerage houses for their own account; they have the money, they're right on top of price movement, they have their own men on the exchange floors to assure getting the right price--and they don't pay commissions.

Other sorts of price disparity lend themselves better to individual participation. Arbitrage transactions can involve the purchase of warrants or convertible bonds and the simultaneous sale of the stock into which they can be converted; short sale of overpriced warrants and the purchase of the related common stock; purchase of convertible bonds and the sale of a call on the related common stock; and, in a proposed merger, buying the stock of the company to be acquired and shorting the would-be parent. This last is a somewhat risky pursuit nowadays, since so many mergers are going on the rocks; but because of the greater risk, profits (in a few weeks) of 20 to 30 percent are common--if the merger comes off.

Even quicker profits have been made by investors speculating in new issues--stock in companies whose shares are being offered to the public for the first time. The year 1968 was a banner one for such wares. Billionaire Perot's company, mentioned at the beginning of this article, was one example, though his stock took a full year to go from $16.50 to $136. A new issue called Educational Computer Corporation ran from $7.25 to $260 in just four months. In September 1968, when Weight Watchers International went public at $11.25, delighted buyers waxed fat as the shares ballooned to an overstuffed $40 on the very day of the offering. And Integrated Resources, Inc., ran from $15 to $41.50 on its first day out; it had two full-time employees.

But speculators who pay large markups for unproven new issues do so at their peril. Whenever the performance of low-priced new issues begins to make headlines, it's a certain sign of excessive speculation. A decline, not only in new issues but in the entire market, can be expected to follow. This happened in 1962, after an orgy of new-issue speculation the year before, and it happened again last year, after the 1968 spree. Ironically, small investors didn't get so badly burned in the most recent new-issue debacle, mainly because the amateurs couldn't get then-hands on too many of the hot new shares. Brokerage houses generally reserve a limited new issue for their best customers--mutual funds, pension funds and high-rolling speculators--all supposedly knowledgeable investors who have been acting out of character in the past few years.

Periodic new-issue benders explain in microcosm why stock prices rise slowly and then fall sharply. Since it's often impossible to say what a company will be like before it goes public, new-issue buyers operate on the Greater Fool Theory, which holds that it doesn't matter what you pay for a hot stock, because a Greater Fool will soon come along to pay more for it. For a time, this can work as a self-fulfilling prophecy. People hear that there's money to be made in the stock market, so they buy shares. The pressure of their buying forces prices up. Higher prices generate more publicity, which in turn lures more newcomers into the market, driving prices higher yet. Buyers begin to expect profits from stocks, not because their certificates represent real value but because stocks seem to go up all the time. But this kind of thinking--whether applied to common stocks or chain letters--carries the seeds of disaster. Someone at the end of the chain, presumably the Greatest Fool, will someday be left holding certificates for which there are no more buyers. The SEC recently attempted to trace the whereabouts of 504 firms that went public during the new-issue boom of the late Fifties and early Sixties. The SEC couldn't even locate 12 percent of the firms; another 43 percent were known to have gone bankrupt; and 26 percent were currently operating at a loss. The remaining 19 percent were actually operating profitably, so perhaps they made some money for those patient and prescient investors who got in, as they say, on the ground floor.

New issues are first sold in the over-the-counter market. As mentioned earlier, this is a vast, complex and tenuously related network of dealers who independently make markets in the tens of thousands of stocks that aren't traded on the big exchanges. Not only stocks but most warrants and corporate bonds--and virtually all municipal bonds--trade over the counter. At this writing, more than 3000 OTC stocks can be purchased at the prevailing 80 percent margin. The rest you must purchase outright, unless you can talk your bank into accepting your shares as collateral against a loan.

Substantial, conservative stocks are traded over the counter--most notably, those of the Bank of New York, which has been paying dividends steadily since the days of George Washington--but the vast majority are small, highly speculative issues that don't qualify for listing on the big exchanges. Understandably, some of the best stock buys (and some of the worst) are to be found here. In 1968, the last year for which complete statistics are available, more than 1300 over-the-counter stocks increased by 50 percent or more (97 decreased similarly) and around 50 increased over 1000 percent. To be sure, 1968 was a very good year, and this record won't even be approached when the final returns come in for 1969. But good year or bad, stocks on the big board don't usually make 1000 percent moves; the last one to do so was Republic Corporation, and that was in 1967.

You buy over-the-counter stocks through your broker, but beyond that, almost everything about the buying process is different. Over-the-counter stocks take their name from the early days of the New York Stock Exchange. Back then, an investor could go to the exchange and buy some stocks at auction; but to buy others, he had to haggle with a banker, over the counter. The same conditions still prevail: Listed stocks are bought by auction, OTC stocks by negotiation. That's why over-the-counter prices are quoted in pairs: bid and asked. The bid price is what some dealer is willing to pay for the stock: the asked price what he is willing to sell it for; and the difference, rarely more than five percent, is usually his profit margin.

Over-the-counter transactions are not given instantaneously on a ticker tape or by computer. Instead, they are compiled every weekday afternoon in a magenta pad of paper known to brokers as the pink sheet, consisting of dealers' buy and sell prices for the various stocks they are willing to make a market in. The over-the-counter bid and asked prices published in the newspaper are a fractional distillation of the information contained in the pink sheet, so they are always a day late. There's also a green sheet, from Chicago, and a white sheet, from San Francisco; among the three, the investor will find buy and sell prices for virtually every unlisted stock in the country.

Usually, you pay standard stock-exchange commissions on an over-the-counter transaction. Your broker will buy at the asked price and take his commission on top. There are no odd-lot fees, but your broker might have to pay a slightly higher asked price for small transactions. Many brokers supplement their income by acting as over-the-counter dealers themselves. So if you're buying an over-the-counter stock on your broker's advice, it's wise to find out whether the purchase will involve him as a broker or as a dealer. In the latter case, the cost should be lower, but there's the danger that instead of offering good advice, he's just trying to move merchandise.

We've pointed up all the specific guidelines, but it's impossible to overemphasize that successful investment is largely a matter of psychology. Every investor has his own style and his own needs. Well-off executives who are pressed for time frequently prefer to put their capital in the hands of investment counselors. For a fee, such men provide professional and supposedly first-rate portfolio management. But even the best investment advisors often fail to recognize that their job isn't over when they've found good stocks. They must then get these good stocks into the hands of investors who can live with them. The family man who keeps savings bonds in a safe-deposit box and hears noises at the front door at night will probably be miserable owning a volatile over-the-counter stock--even if it skyrockets from the day he puts it in his portfolio. For him, every minor reversal will be a portent of imminent disaster. Relief will come only when he's sold the stock. Conversely, the bachelor who spends his pay check remorselessly and gets his kicks breaking speed limits in his Corvette would be equally uncomfortable with a portfolio of gilt-edged blue chips, even if they were to increase steadily every month he owned them. This man doesn't want stability, he wants action, and he will invariably tinker with his portfolio until he gets it. This is why the investment decisions you make yourself--assuming the proper elements of hard thought go into them--are the most satisfactory. Much more than just profit is involved.

While every investor's decisions will differ with his particular situation, a number of precautions and principles apply to all. The observations in the ten paragraphs that follow are simple to state. They all appeal to common sense and, if followed religiously, they will almost surely result in long-run investment success. Yet remarkably few investors--even canny old-timers who know all the rules--have the psychological discipline to act on them consistently.

1. One of the oldest stock-market chestnuts--so hoary that it's been elevated to the rank of cliché--concerns diversification: Don't put all your eggs in one basket. The assumption is that investing in a broad spectrum of companies and industries minimizes risk. But usually, this technique only minimizes profit. The investor who is morbidly preoccupied with avoiding risk should stay out of the market altogether. And the investor who wants to make money should narrow his sights to the very few stocks that seem most promising. Investment writer Gerald Loeb has stated the principle succinctly: "Put all your eggs in one basket--and then watch the basket."

2. Never act on tips, no matter what their source. Only one genre of tip can have any validity: information from corporate insiders. But often, even insiders don't know what they're talking about. (A well-known conglomerateur once advised his own mother not to buy his stock--too risky. The stock then ran from $15 to $165.) Even when insiders do speak knowledgeably, to act on their information before it is broadcast at large is probably illegal. There's little reason why tips from any other sources should include profitable advice. Obviously, chance alone dictates that many of them will. But to get a tip, act on it and then profit handsomely is often the most dangerous course of all. Bad tipsters, like bees, will sting you only once, but the tipster whose information pays off may come to seem infinitely wise, rather than just lucky. He can hurt you repeatedly.

3. Let profits run; take losses quickly and without self-recrimination. One's approach toward losses, rather than profits, usually separates the successful speculator from the ne'er-do-well. To win consistently, you must be willing to admit that you will make mistakes, not just a blunder here and there, but mistake upon mistake. Once again, this is a matter of psychology, but investment success can hinge on it. If you refuse to admit your own fallibility, you'll be reluctant to take losses, a mental paralysis that continually in capacitates the amateur investor. He sees all losses as paper losses and feels that a paper loss is somehow more tolerable than a real one. After all, the market could turn around tomorrow and give it all back. So he sits on a losing situation, waiting for it to return to where he bought it. This ties up capital, sometimes for years, that otherwise could be working productively; and it guarantees the investor--if he's both patient and lucky enough--that he'll someday break even. The losing investor not only lets his losses run but he takes his profits too quickly. "You never lose taking a profit" is a well-intended but erroneous maxim that has gulled speculators since the Dutch-tulip craze. Of course, you can lose taking a profit, if you take it too soon and if it has to cover those inevitable mistakes. Stocks move in trends; once a share starts moving, it tends to keep moving in the same direction. This may be a truism, but it works. Ride along with the trend, perhaps using the progressive-stop technique mentioned earlier, until the stock itself begins to indicate that the move is faltering. If the stock moves considerably, perhaps doubling, consider taking a profit by selling half your shares; that way, you have your original capital for other investments and you retain the other half as insurance against a further move. Whatever you finally sell for is additional profit. Plagued by losses, the unsuccessful investor won't let his winning stocks work for him. He sees every profitable speculation as a potential debacle. At the earliest opportunity, he tiptoes in to steal a miniprofit before the market can take it all back. Overeagerness to grab profits is just as costly as refusal to incur losses. As noted, loss taking is much easier for the technical investor. The fundamentalist, for his own protection, must set some arbitrary loss limit, perhaps 20 percent or so, beyond which he cannot ride with a stock, no matter how sound it might seem. Such an approach will surely miss big moves in stocks that crouch before they leap; but it will keep him out of stocks that crouch only to fall on their faces, thus assuring that he'll still have most of his money to bring to the next opportunity. Just as loss limitation is easier for technicians, so do fundamentalists have less trouble in letting profits run. Since they have their eyes on real value, rather than on the shaky and confusing trail of short-term price action, they are less likely to be frightened out of a good stock on a minor setback. Technicians, for their protection, should refrain from watching the market too closely, once they're in a decisively winning position. If they use progressive stops, they should trail behind them by 10 or even 15 percent, thus assuring that they won't be sold out too early.

4. Don't try to call the tops and bottoms; go with the trend. When prices are rising, successful investors are buying stocks that losers are selling; when prices are falling, the winners are selling back to the losers. This is because the losing investor buys stocks that look cheap--compared with what they were selling for last month. But anyone who buys a declining stock because it looks like a bargain is implicitly betting that it won't go lower. He is trying to call the bottom. He'd do just as well buying lottery tickets. The successful investor would never have the hubris to think he could pick the tops and bottoms. He knows that if a stock is lower this week than last, chances are it will be even lower next week. That's how stocks move. When prices turn around, as they always do eventually, losing speculators tend to sell out when they break even and then steadfastly refuse to buy more, on the grounds that prices are now too high. Typically, prices will continue to advance, perhaps for months or even years, until the loser is finally convinced that they're going to rise forever, whereupon he leaps in precisely at the moment when the winning investor is unloading.

5. Average up, not down. At some point in his investing career, every losing speculator discovers the wonders of averaging down. He buys 100 shares of a stock at $30 and then sits on it while it drops to $20. Here, it occurs to him that he can now get 150 shares for the same price he originally paid for 100, simultaneously reducing his loss--or at least appearing to reduce his loss. Now he has 250 shares, for which he has paid $6000; formerly, the stock had to rise to $30 for him to break even, but now it need go only to $24. If the stock then shoots back to $40, he has made a very wise move. But usually it doesn't. A stock that drops from $30 to $20 will probably drop lower yet. Investors shouldn't sit on declining stocks; and they certainly shouldn't keep sinking money into them while they decline. Averaging up is precisely the opposite technique, and it makes better financial sense, because it goes with the trend, rather than against it. A winning investor might buy 200 shares of a stock selling at $20. If the stock goes down, he'll get out quickly. Only if it goes up would he add to his position. He might buy 100 more shares at $30 and another 50 at $40. He is buying with the trend and, by pyramiding in reverse (purchasing progressively smaller amounts), he is effectively locking in a profit. After his last purchase at $40, the stock could go all the way back to $26 and still give him a profit--though he'd surely be out before then.

6. Never lament hindsight profits; they are as gossamer and as conjectural as the road untaken. If a stock has been good to you and you decide to cash in and go elsewhere, who cares if it keeps rising after you've sold out? A high-flying stock you no longer own is no different from the other highfliers you've never owned. Despite the practical necessity of cutting losses short and letting profits run, once a stock has run, it's both foolish and dangerous to try to squeeze the last dollar from it. Selling at the top is as problematical as buying at the bottom. The pros are quite content to take their profits in the middle. They leave the fringes for the little people. One of the French. Rothschilds, a fantastically successful speculator, wryly explained that he owed his fortune to "selling too soon."

7. As noted, whatever your investment technique, you must be consistent. Don't buy a stock because its chart action looks good and then, when the price goes against you, hold it because it's now relatively cheap on the basis of the fundamentals or because your brokerage house just declared it a buy. If you don't have a consistent plan, you can't expect consistent results. You may make a profit now and again, but you are staking your money on chance rather than on design.

8. Given a technique to apply consistently, you should enter the market only when it promises to give back more than you risk. Good poker players do this instinctively, assessing the odds between the pot and their bet, their hand and the draw. When the odds favor them, they stay in; otherwise, they fold. If the odds in the stock market were as precise as those in poker, investing would be a lot easier. Yet, one can make rough calculations. Figure that the downside risk in any common stock is at least ten percent. This calculus sensibly recognizes the unpredictability of the market. At the outset, every investment ought to be regarded as a speculation: Only when a speculation produces a profit can it be rewarded with the word investment. To assume a ten percent risk in hope of knocking down a five percent gain is to fight the odds. With a presumptive downside risk of ten percent (or more), the investor shouldn't even consider a stock unless it promises profit well over 20 percent. This keeps the odds on his side. If he's right only half the time, he'll still make a profit.

9. As in poker, of course, you should never risk money that you can't afford to lose. Beyond this, you should never commit all your investment funds to make-or-break investments such as puts and calls, where you might blow everything in one mistake. Obviously, if you lose all your money, you won't be able to play anymore. Always allocate enough money to investments that will permit a comeback from the worst imaginable defeat. This might entail being overly conservative with half your stake, so that you can take larger risks with the rest.

10. And when you make a good profit, pull some of it out of the market. The ultimate measure of a successful investor is not the size of his portfolio but how much cash he takes home--for good. Assuming relatively consistent success, you can siphon off three fourths of your net profits each year and still see your investment capital grow handsomely. In addition, you'll be able to enjoy your winnings, which is what the game is all about, or what it should be all about.

Don't think the day of the individual speculator is over. Institutions--mutual funds, savings banks, insurance companies and pension funds--are supposedly dominating the market. Happily for the small investor, the facts don't bear this out. At the end of 1968, the total value of all U. S. corporate stock was 707 billion dollars, and of this, institutions owned only 123 billion dollars--less than 20 percent. The remaining 584 billion dollars was still owned by individuals. True, institutions account for a disproportionate share of the action; recent estimates involve them in half the trades on the big board. This means that institutions are generating huge brokerage commissions; whether they're producing comparable profits remains to be seen. At the current rate, more than a generation will pass before institutions own even half the corporate shares. Clearly, individuals still reign supreme in the stock market and they will for a long time to come. This should be especially good news for the beginning investor with a lifetime of bull and bear markets ahead of him. He probably won't make a billion dollars and, on occasion, he may lose much more than he bargained for. But over the long run, if he plays his hand wisely and well, he'll not only make money but have the considerable satisfaction of knowing he's a winner at a game that tests his own self-mastery.