Book Review: The Psychology of the Stock Market

December 28, 2010
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In the great game that is trading, the game never really changes.

New technology is introduced; new methodologies are dreamed up; new investment fads come and go. But the essentials of trading are the same now as they were generations ago.

There is a class of books that brings home this timelessness. Four of the best are The Money Game by Adam Smith; Devil Take the Hindmost by Edwin Chancellor; Extraordinary Popular Delusions and the Madness of Crowds by Charles MacKay; and of course Reminiscences of a Stock Operator by Edwin Lefevre (with the guidance of Jesse Livermore).

The oldest of the above is MacKay’s book, published in 1841. The Psychology of the Stock Market, by G.C. Selden, is another addition to the “timeless classics” list.

Though published in 1912, Selden’s book could have been published yesterday. This makes complete sense, as the main topic — human psychology — has not changed at all in the past century.

Nonetheless it is eye-opening to realize, with fresh clarity, the degree to which human emotions and purely human thought processes still dominate the game.

But wait, the skeptics say. Surely the nature of trading is at least a little different than what was written of some 99 years ago? Surely the great  masses of market participants have advanced at least modestly since then?

Nope. Still the same.

Selden begins by observing that “Human impulses lead to speculative disasters.” He then goes on to note:

The psychological aspects of speculation may be considered from two points of view, equally important. One question is, What effect do varying mental attitudes of the public have upon the course of prices? How is the character of the market influenced by psychological conditions?

A second consideration is, How does the mental attitude of the individual trader affect his chances of success? To what extent, and how, can he overcome the obstacles placed in his pathway by his own hopes and fears, his timidities and obstinacies?

These two points of view are so closely involved and intermingled that it is almost impossible to consider either one alone. It will be necessary to take up first the subject of speculative psychology as a whole and later to attempt to draw conclusions both as to its effect upon the market and its influence upon the fortunes of the individual trader.

In this very slim volume – fewer than 95 pages, and small pages at that – Selden then goes on to describe with eye-opening lucidity how the stock market “works.”

Of course, being a century old, this uncannily accurate description has nothing to do with dark pools, circuit breakers, high frequency trading, or any modern day influences of the sort. Instead, the focus is entirely on the human element.

To give an example, Selden clearly breaks down the “contest” between investors and speculators, and the characteristic influence of that battle in forming a market top:

In a sense, the market is always a contest between investors and speculators. The real investor, looking chiefly to interest return, but by no means unwilling to make a profit by buying low and selling high, is ready, perhaps, to buy his favorite stock at a price which will yield him six per cent on his investment, or to sell at a price yielding only four per cent. The speculator cares nothing about interest return. He wants to buy before prices go up and to sell short before they go down. He would as soon buy at the top of a big rise as at any other time, provided prices are going still higher.

As the market advances, therefore, one investor after another sees his limit reached and his stock sold. Thus the volumes of stocks to be carried or tossed from hand to hand by bullish speculators is constantly rolling up like a snowball. One the ordinary intermediate fluctuations, covering five to twenty dollars a share, these sales by investors are small compared with the speculative business…

Selden deftly parses the logic behind patterns of market action that every seasoned trader has lived through. These descriptions are so logical, and for swing traders so confirmed by present day experience, that you can feel their power in your gut (the same place where trader’s intuition resides).

In sum, Selden’s book is masterful in the way it highlights, very simply and cleanly, the interplay of thoughts and emotions on both sides of the aisle as the market ramps up, tops out, comes crashing down, and then repeats the process ad infinitum. Just as the author predicted it would.

In some ways, Psychology of the Stock Market is a far more valuable book today precisely because it was written so long ago. The great yawning gap of technological distance and time leaves no temptation on the part of the reader to assign special conditions of modern technology or modern thinking to the psychological drivers being described. Instead, they can simply be taken as the unadorned influences they are.

When one can trace the contours very plainly of what was important in the first decade of the twentieth century, and see that the same factors still dominate in the twenty-first, it becomes far more readily apparent what is truly vital (in terms of understanding markets) versus what is not. There is a reason why books like this tend to last, while the vast majority of high-powered academic theories get scrapped.

Being such a slender and easily digestible read – yet so packed with keen insight – I give Psychology of the Stock Market the highest honor I can think of: Assigning it to my exclusive circle of “must read” trading books, of which there can only be half a dozen or so. (Lefevre’s Reminiscences and Schwager’s original Market Wizards being two other examples.)

To conclude: In terms of food for thought, knowledge imparted, and potential impact on the trader, The Psychology of the Stock Market punches far above its weight. If you haven’t spent much time considering the “metacognitive” aspects of the trading game – thinking about what others tend to think and why – this is an excellent place to start.

JS

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3 Responses to Book Review: The Psychology of the Stock Market

  1. Frank B on January 11, 2011 at 1:14 pm

    Just read the book, thanks for the recommendation. It's an excellent book; concise, direct, and relevant. Generally books written 100 years ago get to the point quickly. It reminded me of Reminiscences of a Stock Operator and the Jesse Livermore biography (can’t remember the exact title) . If that book had been written today it would be 500 pages and so convoluted that drawing meaning and usable ideas would be difficult at best.
    What I found most interesting: Nothing has changed in the last 3000 years, a market is a market whether you get your info on a stone tablet, a chalk board, a newspaper, or a computer screen. There is always BS and noise to be filtered out.

    Every trader, investor, or speculator should read it. (read it on line at Google, http://www.archive.org/stream/psychologystock00se
    Thanks
    Frank B

  2. Anonymous on September 14, 2012 at 9:58 am

    Jack, eagerly waiting for your exclusive circle of “must read” trading books.

  3. Kay on November 7, 2012 at 10:26 am

    While working with an estate planner, I picked up this book at an estate sale just for curiosity sake only to find it is an original 1912 edition. Loved the book.

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