Chart Advisor: Bob Farrell Told Me

By Louis Spector

Bob Farrell Told Me

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Bob Farrell Told Me

I had the privilege of speaking with the legendary Robert Farrell at the CMT Association’s Midwinter Retreat in Tampa. He recommended I read a book called One-Way Pockets: the book of books on Wall Street speculation. Published in 1917, it was written by Don Guyon, the fictitious name of a man working in a brokerage house during the War Bride bull market of 1915. It is my hope to relay some timeless market wisdom, study some market history, and share a book recommendation from our first president.

History & Background

The year is 1915. Electricity, the internal combustion engine, running water in our homes, and the desire for city life over rural life are all changing the way we live. US equities have been in a secular trading range since 1900. We are in the midst of the War Bride bull market following the start of World War 1. See chart 1.

Chart 1. Courtesy of Optuma.

World War 1 officially started on July 28th, 1914. Trading on the New York Stock Exchange closed from July 30th to December 12th, 1914, as foreign investors began liquidating their holdings to raise money to fund the war. When trading resumed, The Dow Industrial average gained more than 86% over 257 trading days. This rally was fueled by the government as it began spending heavily to produce goods for the Europeans to purchase to support the war. The 1915 rally was led by the aptly named War Bride stocks, including munition, iron, steel, shipping, and textiles. See chart 2.

Don Guyon (DG), working in a brokerage house in December 1915, had a difficult time understanding why speculators were losing money at the end of such a spectacular bull run. To figure this out, he went through the accounts of six of the brokerage’s largest active traders. He analyzed their transactions from July 1st, 1915, to February 29th, 1916. See chart 2. He concluded, “…the trading methods of each [speculator] had undergone a pronounced and obviously unintentional change with the progress of the bull market from one stage to another”

Chart 2. Courtesy of Optuma.

After doing his study by analyzing his brokerage’s order book, DG concluded that the speculators’ behavior was backwards. They were doing the exact opposite of what they should have.

• When the bull market was in its infancy, DG found that speculators were taking quick, small profits and small losses. They were also using stop orders for protection.
• As the bull market continued, they repurchased these stocks at higher prices. This time though, they took profits on larger gains than before. Some lost money by shorting in an attempt to call the top.
• Even further into the bull market, speculators stopped taking any profits at all. They also stopped using protective stop orders, even as stocks doubled. The speculators did not want to be stopped out again.
• They sold too soon, repurchased at higher prices, quit using stops, bought more stock after the market finally started distribution, and sold long positions on breaks lower instead of on rallies.

Before we get to DG’s trading methodology, he eventually offers the following regarding a speculator’s psychology. “The operating method I have outlined is not fool-proof or otherwise infallible… But the speculator who adhered closely to its rules may at least rest assured that his trading methods are diametrically opposed to the trading methods of the great majority of speculators – and the great majority of speculators are, as we know, consistent losers in Wall Street.”

and

“The man who applies this or any other speculative method successfully must be able to exercise patience and self-control, to withstand all forms of mental temptation, to ignore the dictates of fear and greed, and to disregard everything he hears, sees, or reads that may cause the slightest deviation from his course.”

and

“The few who make money in the stock market await what they consider exceptional opportunities and then play for profits that are worthwhile. They look ahead a week or a month or a year, as the case may be, and disregard the changes that occur in the price movement in each daily session, which to the daily trader assumes exaggerated proportions.”

DG’s Plan to Speculate Covering a Complete Market Cycle

First determine the trend of the overall market, and then speculate in that direction. Be careful of rangebound markets, but if desired buy low and sell high.

How a bull market starts/when to get long:

• Most speculators become convinced of a bull swing when it approaches its culmination.
• Bull markets start after a protracted period of dullness and narrow fluctuations. Price breaks through the trading range with increased activity on the advances. Sometimes many stocks advance, while at other times the advance is narrow. Look for leaders entering new high territory as confirmation.
• Bull markets might also begin after a period of declining prices when the market advances or refuses to go down on bad news. Look for when the market finally advances above the point where it was before the bad news as confirmation.

DG also tells us:

• It is just as important to determine what to buy as when to buy. He recommends two or three active stocks, and he recommends buying stocks that have declined the least.
• Write a trading plan before making any commitments. He reminds us that our judgement is most logical before having money in the market, which tends to warp ones sound judgement
• Use protective stop orders, and enter them at the same time as buy orders. Never lower or cancel them. Raise them in accordance with your predetermined plan. Set them based on market action/price. They should take you out of your positions when your idea is no longer valid, not based on an arbitrary number of points or a percentage.
• Follow the plan. Do not change the plan because of news, market action, or any other outside influence based on things we hear, read, feel, etc…

Seeing the first reaction through:

You are now long. Your stocks have advanced for several days. DG tells us:

• Do not make the mistake of trying to find the top and play for a reaction.
• Do not sell, even if you are convinced the advance has gone too far too fast. This is the opposite advice of the cliche’, nobody ever goes broke taking a profit. He disagrees.
• Stay invested as the issue pulls back 50% or more.
• Add on strength when the price begins to resume its advance and the correction appears over. This second purchase should also have a protective stop.

The first selling point:

• Your original line of long stock should be sold on the recovery to the former highs, while the stock bought on the reaction should be retained.
• This process of buying shares on strength after pullbacks and selling shares at the previous swing highs should be repeated as long as the market continues to advance into new high territory.
• Do not make purchases at new highs. “…this temptation is fatal alike to his mental attitude and the success of his operations.”5

The great distributive stage:

• The market usually has several successive days in which the volume of sales is very large and speculative excitement is intense.
• Stocks under distribution will have sharp but short-lived advances, followed by gradual declines.
• There will come a time when, instead of resuming the advance, stocks will go sideways near their previous top. The action will look similar to the past and the public will again buy. This is the time to exit your position. Stock has been transferred from the strong hands to the weak hands.
• Exit your position.
• f this is happening at the broad market level, it is time to “get out of all stocks and stay out, regardless of the strength displayed by certain issues… Not only is this the time to sell long stock, it is also the time to put out a line of shorts.”

When and what to sell short:

• In contrast to buying stocks long, look to short the weakest issues. These are the ones breaking down from ranges well below their highs instead of at or near their highs.
• Limit your losses using stops, just as you did on the long side.
• Use the same tactics as longs, just in the opposite direction.
• Remember, when selling short, rallies will be very, very sharp. Instead of covering too early, “cover your complete line only when the market no longer goes down on bad news or when it moves upward through a trading area…”7

Final Thoughts

DG’s perspective is a fascinating one. He studied actual buy and sell orders of unsuccessful speculators, and then he crafted trading guidelines which do the exact opposite of what they did. He shared important psychological ideas. He even made the case for Technical Analysis as a discipline: “To tell a speculator to base his operations on his interpretation of fundamental factors is to leave him just where he started…The market itself determines the relative importance of all factors more accurately.”

I encourage you to read this book, and I again thank Mr. Farrell for this recommendation. In closing, DG tells us, and I believe Mr. Farrell would agree, “…the only speculative method that would prove profitable in the long run must be the reverse of that followed by the consistently unsuccessful public.”

Quotes taken from Guyon, Don. One-Way Pockets: the book of books on Wall Street speculation. New York, New York: Cosimo, 2005

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Originally posted 6th May, 2024