How To Be An Investment Survivor

THE EARLY YEARS

Gerald M. Loeb was born in San Francisco in 1899, and later recalled that his earliest vivid memories were of the earthquake and fire that destroyed much of the city in 1906. He began his financial career as a bond salesman in his hometown, where he became a local celebrity because of the many articles that he wrote for area newspapers about investing. While still in his early 20s, he moved to New York to work for E.F. Hutton & Co. He became a partner and was the firm's public spokesman for many years.

Loeb was an unabashed technician who relied on "the tape" — that is, information about price and volume, which in his day was conveyed by ticker tape machines. According to Loeb, the most important thing to master in Wall Street was the tape: He strongly believed it was possible to make a lot of money by seeing just the tape. He considered it to be a safety valve and automatic check on every trading action — if the trader understood how to read it.

THE FIVE RULES

Loeb set forth five rules of stock market investing:

1. Buy only leading companies that are actively traded.
2. Be aware of a stock's trading range and do not overpay.
3. Do not overdiversify.
4. Limit your losses; do not hold onto a "bad stale position."
5. Do not always be fully invested; keep a cash reserve unless an exceptional opportunity presents itself.

With regard to the last point, Loeb asserted that an investor should "aim at a real profit" and "reject everything that does not promise to advance generously." If excellent prospects could not be found, he advised traders to stay out of the market, only buying when "a particularly opportune time presents itself."

Loeb lived through many bull and bear markets in a career that spanned the "Roaring" 1920s and the "Go-Go" 1960s, with booms and busts in between. He had respect for the uncertainties of the market. He observed in the late 1960s that stocks sometimes make bottoms and seem so cheap that investors actually mistrust their own intelligence. He also observed that prices reach bottoms that suggest that the shares in question are actually a good short sale. Yet, he noted that "shares have a habit of sometimes seeming dear in the early stages of an advance, and later at far higher levels new and unexpected developments often make them seem cheap again."

In 1937, when most stock market investors focused on dividends rather than capital gains (because they had been burned by the Great Crash of 1929 and the bear market that followed), Loeb said that investors should "forget dividends and look to capital gains." By carefully timing investments, he wrote, above-average profits could be obtained.

By way of example, Loeb pointed out that a $1,000 investment in a stock paying a $50 dividend and likely to advance only a dollar or two a share in the coming year will produce an annual profit (dividends plus capital gains) of about $70, but a $1,000 investment in a stock paying no dividends but that doubles in price will bring a profit of $1,000.

At the time that he first urged the public to "invest for appreciation" rather than dividends, back in the 1930s, it was considered a radical idea. "The most important single factor in shaping security markets," according to Loeb, "is public psychology." It is because of investor confidence or a lack of it (which he denoted as "market factors") that a stock could sell on one day with a price/earnings ratio (P/E) of 40, but not find buyers on another day with a P/E of 10.

TRENDS

Loeb was not alone in observing that market factors move in trends and that "the averages work in favor of those who assume the trend in being will continue until proven changed." He added that "this applies both for the company in question, industrially speaking, and the price trend of a stock, tape-wise" — in more modern terms, both fundamental and technical analysis.

Today, Loeb's approach to investing is known as momentum investing — finding stocks that are on an upward trend and riding the movement until prices begin to falter. "Stocks that are high and going higher are a good buy," he stated. "Stocks that are 'cheap' and growing cheaper don't interest me from a buying angle." Although experienced traders have probably always known that stocks with prices that have risen are more likely to continue to rise until some event or factor ends the trend, it was not until the early 1990s that academic studies supported the idea. Before then, most economists and other academics dismissed the notion of momentum investing as wishful thinking.

Unfortunately, momentum does not last forever. The key to successfully applying the concept is to be able to anticipate when the trend is about to change.

Loeb believed that trying to pick the top or bottom of a market was unrealistic. "It is better to be 'late and sure' than 'early and doubtful,'" he explained. He added that "for most of us, detecting the change after it has occurred, but before it has proceeded too far, is still a very profitable and to many an attainable goal."

After all of his years analyzing the markets, Gerald Loeb concluded that "a little horse sense is far more useful than a lot of theory."

James Maccaro is an attorney and freelance writer. He has written articles for Newsday, Ideas on Liberty, the Massachusetts Law Review, and other magazines. He can be reached at jam@juno.com.

SUGGESTED READING

Current and past articles from Working Money, The Investors' Magazine, can be found at Working-Money.com.