From The Stock Market Barometer by William P. Hamilton, published in 1922

Trading Volume and Direction of Stock Market Averages

Continued from...Prediction of the Recovery into a Bull Market

Relevance of the Volume of Trading

It is worth while to note here that the volume of trading is always larger in a bull market than in a bear market. It expands as prices go up and contracts as they decline. A moment's thought will reveal the reason. When the market has been under long depression many people have lost money, actually and on paper, and the fund for speculation or speculative investment is correspondingly contracted. On the advance, however, many people are making money, actually and on paper, and the wellnigh universal experience has been that in the last stages of a bull market they trade in stocks beyond their real resources. This is uniformly true of major bull swings, but is subject to great modification in the secondary movements. A sharp reaction in a bull market will often stimulate the volume of business. There is a picturesque example of this in the most spectacular reaction of the kind. The average monthly sales in May, 1901, have not been closely approached since. They were more than one million eight hundred thousand shares a day, including Saturdays, when there is only two hours of trading, and it was on the 9th of May that the Northern Pacific panic took place. There will be an opportunity to take up the secondary swing in some detail in a future discussion, and it is not necessary for our purpose to expand upon, the subject now.

An Unbiased Mind

Not to be tedious, but to counter the charge of saying "I told you so," on ex post facto evidence, it has been necessary to offer these examples of the practical use of the stock market barometer. There is, indeed, little in these predictions to excite boasting. Any intelligent student of the averages who has once grasped the principle of the stock market barometer can draw such deductions for himself, provided he brings to the task a really unbiased mind. An interest in the stock market would be almost certain to weaken his judgment. It is only human to foresee what you hope and, indeed, what you expected when you bought stocks for the rise or sold them short. But the analyst of the price movement, writing for the guidance of others, must be absolutely disinterested. There are all sorts of traps to catch him if he is not, particularly if he has previously committed himself to inferences not clearly justified by the premises. Sheer pride of opinion has ruined more speculators in the stock market than all other causes put together.

An Unfortunate Guess

One of the shortest ways of going wrong is to accept an indication by one average which has not been clearly confirmed by the other. On May 10, 1921, the New York American ventured into prophecy on, its financial page. To reinforce its prediction its forecaster published a reproduction of the Dow-Jones chart. As the chart and the accompanying figure were taken without acknowledgment, altruists who believe that ill-gotten gains do not prosper will hear with satisfaction that the author of the Hearst American article did not even understand the meaning of what he had appropriated. He announced a bull movement for the industrial stocks, even prescribing its limits, a degree of prophecy hitherto unsuspected in the barometer; while the railroad stocks, as he expressed it, "marked time". It was a most unfortunate guess, for the industrials declined a further thirteen points, making their new low in June; while the railroads, so far from marking time, also showed substantial reaction.

Averages Must Confirm Each Otlier

This was a case where the observer was misled by a bullish indication given in the industrial average which was not confirmed by the railroads. The former had been making what we have learned to call a line, and after a secondary rally in a bear market showed some strength, at a figure above the line and calculated to suggest accumulation if there had been any evidence of the same thing in the railroad stocks. But there was nothing of the kind; and it is to be hoped that the readers of, the Hearst American article did not follow the tip; for the industrials, as shown by the averages, did not cross the closing figure of the day on which the bullish advice was given until the second trading day of December, seven months after.

It is possible, however, for us to assume charitably that this expounder of the barometer was not quite so superficial as he sounds. There may have been in his mind a recollection of the bull market of 1919, which the industrials made entirely off their own bat. If you will study the chart published with a later chapter, headed "An Exception to Prove the Rule," you will see that such an experience could not be repeated unless our railroad stocks returned to government ownership and guaranty - a condition which at that time took them entirely out of the speculative class and left them moving downward with bonds and other securities held for fixed income. These, as we know, inevitably decline in price with an advance in the cost of living, which was then in full flood.

This illustration serves to emphasise the fact that while the two averages may vary in strength they will not materially vary in direction, especially in a major movement; Throughout all the years in which both averages have been kept this rule has proved entirely dependable. It is not only true of the major swings of the market but it is approximately true of the secondary reactions and rallies. It would not be true of the daily fluctuation, and it might be utterly misleading so far as individual stocks are concerned. The indications of a single average can, and do, look seductively like the real thing, as I have discovered to my cost; for in that way I find, upon analysis of articles written long ago, that I more than once went wrong. It says much for the value of our barometer that error came from trusting it too little rather than too much.

Sticking to Our Text

It has been suggested that I should discuss the causes which were related to the major movements of the stock market - the depressions in business, the recoveries and the alleged or real overexpansion. I have my own opinion about the causes of the panic of 1907. I do not agree with writers rated as competent as myself, who ascribe it to E. H. Harriman and the "overexpansion" of the American railroads from 1901 to 1906; who choose to think that the advance in the Bank of England rate to the sufficiently startling figure of 7 per cent at the end of 1906 was a direct result of gambling in railroad stocks by Mr. Roosevelt's "malefactors of great wealth." And by no stretch of faith can I believe that Harriman produced a panic in Alexandria, Egypt, in April, 1907; another in Japan within a month; what the London Economist called "the biggest financial disaster that had overtaken the city since 1857" in Hamburg in October; and still another in Chile - all preceding our own crisis at the end of October. It has seemed to me that the subsequent paralysis of railroad development, which should have gone on at the billion-dollar-a-year rate James J.Hill suggested in 1906, but was suspended almost entirely, was a much more serious matter for the country than the reciprocal ownership of railroad stock of E.H. Harriman's plans. There could be no menace to the public there, with the Interstate Commerce Commission to protect us through the freight rates.

But all this is beside the point. I am writing about the barometer, not about the weather. History reads queerly fourteen years after the event to those who were in a position to know the facts, who might even have been, to at least a modest extent, part of that history. But where it is necessary to review history here these discussions will still stick to the text.

Previous...Prediction of the Recovery into a Bull Market Next...Nature and Uses of Secondary Swings

From The Stock Market Barometer by William P. Hamilton, published in 1922