Review: Jesse Livermore’s Methods of Trading in Stocks By Richard Wyckoff
This book is a short collection of articles from the Magazine of Wall Street (out of print) that resulted from interviews Richard Wyckoff had with Jesse Livermore (1877-1940). During the publication of these articles, Jesse Livermore was widely considered to be a major force in the markets. These interviews occurred later in Jesse Livermore’s life when his investing style had shifted from his early very speculative and short-term focus strategy, which is detailed in the Reminiscences of a Stock Operator
Chapter 1. Meet the Markets Greatest Trader
Mr. Jesse Livermore emphasizes that most inexperienced investors make a mistake of buying securities cheap just because they are selling at a low price. Price alone does not determine cheapness. An investor must determine which industries are in the strongest position and which ones are weaker. Livermore believes the best practice is to eschew weak industries and cheap stocks without a firm foundation. When there is a declining market movement these weak industries and cheap stocks will likely be the first to decline, while also facing the greatest resistance to price recovery. Such an effect, is usually the result of a fundamentally weak competitive position. The investor should consider possible investments in (1) the strong industries with the strongest stocks and (2) the industries with the most promising future under present conditions. Through investigation an investor will be able to identify those conditions that affect one industry well while hurting the other industries. Livermore states that not all investments rise at the same time, everything has a season and the investor should time their investments around this factor. Furthermore, investors should maintain a meaningful portion of capital as liquid in order to fully profit when the right opportunity develops. Finally, patience, conviction in one’s ideas, and knowledge are essential to stock market success.
Chapter 2. How He Prepares for the Day’s Work
Livermore spends his evenings and early mornings looking for vital fundamental facts regarding companies, the economy, and commodities. He then meditates upon these and forms conclusions, which he will test on the market. He usually retires to bed by 10:00 pm and awakes early. He believes that to be a strong force in the market, one must study the market and the underlying factors much in the way that doctors and lawyers must attend years of school to master their subjects. Ultimately, he believes that no individual will succeed on a consistent basis in the stock market without acquiring “a fundamental knowledge of economics and thoroughly familiarizes himself with conditions of every sort” with regard to a company’s operations, history, industry, and price action. An investor must: (1) investigate the company; (2) investigate the economy; (3) have patience; and (4) be prepared to take action on a position when different scenarios develop.
Chapter 3. The Special Arrangement of His Office
Livermore controls the atmosphere of his life and operations. During his operations, he will work with few distractions like phone calls or other correspondence. He prefers silence for his concentration and thoughts. His success is derived from his anticipation of future events and stock moves. He must be clearheaded to anticipate these moves and judge the impact of news events on the market. Livermore does his best to eschew hot stock tips as well as the opinions of others with regards to the stock market. When listening to these outside thoughts, he risks unraveling his confidence in his positions and the logic behind them. Furthermore, Livermore believes in developing poise and maintaining a logical mind during all market reactions. This poise has to be developed and can be strengthen through exercise and maintaining good physical condition. Moreover, he studies psychology due to his belief that the market is a psychological machine.
Chapter 4. How Livermore Reads the Tape
Livermore is a large advocate of market timing in his stock purchases. He believes that an investor must understand: (1) the fundamental position; (2) the long trend of the market; and (3) the current psychology of the market, which can be seen through tape reading. Thoughts of investors and pundits have little meaning, what matters are those actions that are implemented in the market. Livermore studies the tape looking for strength, weakness, changes in volume, large players’ actions, insiders’ actions, the performance of industries, and other considerations. Through his study of the tape, Livermore could change his positions and his opinion regarding the best way to play the market. Livermore believes that the truly large profits come from recognizing turning points that result in long swings. For example, he may have the fundamental opinion regarding commodities that although there is a current oversupply, there will be a shortage in the near future. Based on this thought, he will continue to watch the market action waiting for that moment when others recognize his thoughts and begin buying. In general, when judging these turning points he tries to focus on support and resistance levels. Usually before a turning point the price action will hit the resistance levels or support levels with more frequency. Nevertheless, Livermore does not try to squeeze in the last amount of profit before a turning point. Tape reading takes time and practice to perfect, especially in today’s environment which has changed significantly since Livermore’s time. Yet, in general, tape action is simply recognizing the supply-and-demand forces on the price action and then following the more dominant force.
Chapter 5. How He Makes His Commitments and Limits His Risk – His Minimum Prospective Profit
Livermore manages his risk by (1) cutting his losses while they are small and (2) only investing in opportunities that can potentially yield a large profit. These limits should be set by the individuals with regards to their own preferences. Livermore arranges his trades so that if two of three trades yield small losses and one yields at least his minimum profit expectation, then he will have an overall positive yield for those three trades. Most average investors tend to hang on to their losses, while cutting their profits shorts. The opposite mentality must be adopted, let profits run while cutting losses short.
Chapter 6. How He Keeps His Capital Turning Over
Two of Livermore’s more valued strategies are his use of (1) a price stop (as discussed above) and (2) a time stop. He believes that his capital is the blood of his business. If a stock investment goes against him with regards to price, then he will close out the position. If a stock investment does not perform the way he would like within the time period he established for that stock, then he closes out the position. An effective trader cannot waste his money on stocks that are not performing. Livermore believes that trades based on hope can result in an investor holding onto a position for too long and eventually taking an investment loss. In such a loss, the investor incurs both opportunity cost and the loss. This mentality allows Livermore to quickly take advantage of large market swings instead of becoming a victim of them due to hope for potential positions.
Chapter 7. The Kind of Stocks in Which to Trade
The main take away from this chapter is that Livermore prefers selecting stocks that are: (1) actively traded; (2) in the strongest industries; (3) have wide swings over short periods of time; and (4) offer large profit possibilities. He does not waste his time studying or investing in stocks that do not have the ability to move outside a narrow trading range.
Chapter 8. Livermore’s Method of Pyramiding
This chapter briefly discusses the pyramiding and money management techniques that Livermore adapted as he became older and managed greater amounts of money. In Livermore’s time, pyramiding was nothing new and had been used by many successful stock market operators in the 1800s. Livermore had utilized the technique with much success throughout his career. Basically, the idea behind pyramiding is that as a market position continues to perform favorably, the investor adds to the size of that position. This is the opposite of averaging down, which is a situation where the position goes against the investor and he then adds to the position. Livermore believes in cutting losses rather quickly and would never average down. Yet, through much experience, he decided that the best way to pyramid was not to continue to invest in a position as it moved more favorably in one direction. Instead, he believed it was better to establish a full position through a few large trades early in the favorable movement. Consequently, he was able to protect his capital against sudden adverse unfavorable movements in the position. Furthermore, he stated his belief in maintaining an amount of cash on hand to quickly participate in possible rewarding market opportunities.
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Tagged with Book Review, Investing, Jesse Livermore, Money Management, Pyramiding, Richard Wyckoff, Trading
