Edson Gould: The “Gould-en” Rule to Stock Market Investing
by Robert Williams, Advisory Panelist, Investment U
Friday, February 20, 2009: Issue #940
To appreciate why we favor companies with consistently good earnings and discourage efforts to time the market, you have to consider the often overlooked studies of Edson Gould.
Gould is regarded as one of the best market technicians of all time, albeit his enviable track record was logged during the 1960s and 1970s, before the Dow had even cracked the 1,000 level.
All the same, he’s relevant because he was the first to suggest that economic fundamentals and monetary conditions alone couldn’t explain (or predict) stock market behavior.
He began his exhaustive studies as an analyst for Moody’s in the 1920s, intent on building a model that could accurately predict the movement of stocks.
Edson Gould had great difficulty finding a relevant pattern to the stock markets. In his frustration, he stumbled upon a principle that guides our understanding of the psychology of the markets even today. And for investors, following the “Gould-en rule,” regardless of market conditions – is profitable.
Edson Gould – Finding Stock Market Answers
Edson Gould carried indexes back as far as 100 years, incorporating everything from Newton’s laws of motion to quantum physics, and found that regardless of how much you knew about the underlying fundamentals, you still didn’t get very accurate stock market answers.
“I recognized that economic and monetary forecasts and trends were vital in projecting stock prices three and four years out, but came to the realization that they could have little value when trying to forecast stock prices over a period of weeks, several months, or even as many as two years,” said Gould.
He knew another key variable was at play – one that would fill in the blank, so to speak, and explain the market’s random behavior (over a shorter time period).
Everything changed when Edson Gould read the book “The Crowd,” by French social scientist Gustave Le Bon, which was a study of the popular mind based largely upon the experience of crowds in the French Revolution.
Edson Gould’s Stock Market – Mass Crowd Psychology
Upon reading and re-reading the book, Edson Gould “came to the initial realization, since reinforced, that the action of the stock market is nothing more nor less than a manifestation of mass crowd psychology in action.”
And given that crowd psychology is not something that can be accurately predicted, trying to surmise the stock market’s next directional move is folly.
It’s simple really.
Easy money and an economy that fosters prosperity make the likelihood of an extended bull market very good. Strained banking resources and guarded spending limit the possibility of such a price advance.
Everything the market does – the day-to-day volatility of prices – can be attributed to the mood swings of the crowd.
Think of the stock market as an emotional auction of sorts:
- The market auctions up until there are no more buyers.
- Then it reverses and moves down until there are no more sellers.
All market activity occurs within this framework. Through this lens, it’s easier to understand how psychology directly affects the manner in which the auction commences.
By focusing on proven investment strategies, we can remove ourselves from some of the influences of the crowd.
The “Gould Standard” – Companies With Strong Earnings
Consider sound companies with consistently strong earnings as the “Gould standard.” And the poorly managed companies, which regularly miss Wall Street expectations, as hunks of lead.
Focusing your holdings on these proven winners – companies where investor psychology will always tip back in your favor – is the one of the best ways to remove uncertainty and emotion from your portfolio.
As Alexander Green says in his book “The Gone Fishin’ Portfolio,” “Over the long term, there is one thing about equities that you can safely take to the bank: Share prices follow earnings.
“Look back through history and try to find even a single company that increased its earnings quarter after quarter, year after year, and the stock didn’t tag along. Conversely, try to uncover one whose earnings declined year after year and the stock continued to move up. It just doesn’t happen.”
Gould often referred to the stock market as a crowd void of reason, which simply reacts animalistically and emotionally. Just know, that following the crowd is no way to build long-lasting wealth. And in the short term, may lead you over a cliff.