CHAPTER VI.

*THE TWO GENERAL METHODS OF TRADING.

There are two general methods of trading. One is to deal in active stocks in comparatively large amounts, relying for protection upon stop orders. In this method of trading it is not necessary to know much about the values. The point of chief importance is that the stock should be active enough to permit the execution of the stop order at the point selected so as to cut losses short. The operator, by this method, guesses which way the stock will move. If he guesses right, he lets his profits run. If he guesses wrong, he goes out on the stop order. If he can guess right as often as he can guess wrong, he is fairly sure of profits.

The other system is an entirely different proposition. It starts with the assumption that the operator knows approximately the value of the stock in which he proposes to deal. It assumes that he has considered the tendency of the general market; that he realizes whether the stock in which he proposes to deal is relatively up or down, and that he feels sure of its value for at least months to come.

Suppose this to exist: The operator lays out his plan of campaign on the theory that he will buy his first lot of stock at what he considers the right price and the right time, and will then buy an equal amount every 1 per cent. down as far as the decline may go.

* Dow's Theory.

This method of trading is the one generally employed by large operators. They know the value of the stock in which they propose to deal, and are therefore reasonably secure in following a decline. They feel about a stock as merchants feel about buying staple goods. If an article is cheap at $100, they know it is cheaper at $90, and will strain a point to buy at $80 or at $70, knowing that the price must recover. This is the way a large operator looks at his favorite stocks and this is why he generally makes money

in them.

The disadvantage of the small operator in following this method is two-fold. He does not absolutely know the value of the stock. That is, he may know the truth up to a certain point, but beyond that is an unknown factor which interferes with the result. When the price of a stock declines considerably, the small operator always fears that he has overlooked something of importance, and he is therefore tempted to sell instead of averaging his holdings.

The second disadvantage of the small operator in following this policy is that he seldom provides sufficient capital for his requirements. Thousands of speculators believe that because 10 per cent. is a common speculative margin, that $1,000 justifies them in trading in hundred share lots. This impression produces losses continually.

The man who has $1,000 for speculation is not well equipped for trading in even 10 share lots, if he proposes to deal on a scale. A comparison of high and low prices of active stocks shows frequently a difference of 30 points in a year. Any operator proposing to follow a stock down, buying on a scale, should make his preparations for a

possible fall of from 20 to 30 points. Assuming that he does not begin to buy until his stock is 5 points down from the top, there is still a possibility of having to buy 20 lots before the turn will come.

If, however, an outsider will provide $2,500 as his speculative capital and will trade in ten-share lots in a thoroughly good railroad stock, beginning his purchases only after a decline of five points in a rising market, and ten points in a bear market, following the decline with purchases every point down, and retaining all the stock bought, he seldom need make a loss.

Such campaigns require time, patience, and the pursuance of a fixed policy, but whoever will follow this policy will find himself able to get a high rate of interest on the capital invested. It is an old saying in Wall Street that the man who begins to speculate in stocks with the intention of making a fortune, usually goes broke, whereas the man who trades with a view of getting good interest on his money, sometimes gets rich.

This is only another way of saying that money is made -by conservative trading rather than by the effort to get large profits by taking large risks. After allowing for all the risks involved, we think the outsider who wants to trade in stocks has a better chance working in small lots on a scale than in any other way, provided he will pay attention to certain essential points, which for convenience of reference we will enumerate in order..

1.-Bull markets and bear markets run four and five years at a time. Determine by the average prices, which -one is under way.

2.

Determine the stock or stocks to trade in. They should be railroad stocks, dividend payers, not too low, nor too high, fairly active, and for the bull side below their value; for the bear side above their value. Values are determined roughly by the earnings available for dividends.

3.-Observe the position of your stock with relation to recent fluctuations. In a bull market, the time to begin to buy is when a stock has had four or five points decline from the last previous top. In a bear market, the time to begin to sell is when such a stock has had three or four points rally from the bottom.

4. Stick to the stock bought until a fair profit or until there is good reason for deciding that the first estimate of value was wrong. Remember that an active stock will generally rally from 3% per cent. to 5% per cent. of the amount of its decline under adverse conditions and more than that under favorable conditions.

5. Have money enough to see a decline through without becoming uneasy or over-burdened. $2,500 ought to take care of a ten-share scale every point down-that is to say, supposing the first lot to be bought five points down from the top, $2,500 ought to carry the scale until the natural recovery from the low point brings the lot out with a profit on the average cost. It will not do to expect a profit on every lot, but only on the average. In a bull market it is better to always work on the bull side; in a bear market, on the bear side. There are usually more rallies in a bear market than there are relapses in a bull market...

6:-Do not let success in making money in ten-share

lots create a belief that a bolder policy will be wiser and begin to trade in 100-share lots with inadequate capital. A few hundred-share losses will wipe out a good many tenshare profits.

7.-There is not usually much difficulty in dealing in ten-share lots on the short side. If one broker does not wish to do it, another probably will, especially for a customer who amply protects his account and who seems to understand what he is doing.