In this post I take a look at one of the greatest traders of all time, Jesse Livermore. Jesse was famously profiled in the classic investing tome Reminiscences of a Stock Operator, a book that has been called the best trading book every written.
This is a long piece, clocking in at around 9,000 words and it covers all of Jesse’s most important trading lessons. The quotes are taken directly from the original book by Edwin Lefèvre.
Introduction to Jesse Livermore
Jesse Livermore was born in Massachusetts, in 1877. By the age of fifteen he went to work in Paine Webber’s Boston brokerage office where his job was to post the stock and commodities prices on the chalk board.
He studied the price movements of the stocks on the ticker boards and before long began to trade on their fluctuations.
When Jesse Livermore was in his twenties he moved to New York City to speculate in the stock and commodities market full time.
Over a time period of forty years of trading, Jesse developed an incredible skill for speculation and is said to have accumulated and lost millions of dollars several times over.
At the peak of his fortune, in 1929, Jesse was said to be worth around $100 million. It’s not easy to estimate but in today’s money, that would be worth somewhere between $1-14 billion.
But Jesse didn’t earn that money trading other people’s funds. He was a completely self-made man, trading with his own money and the type of returns he managed to make are unthinkable in today’s markets.
Jesse earned the nicknames of Boy Wonder, Boy plunger, and the Great Bear of Wall Street, and his story is one of the most fascinating ever told on Wall Street.
In 1923, a financial journalist named Edwin Lefevre interviewed Jesse and published a book on the trader’s life called Reminiscences of a Stock Operator.
To this day, the book remains a Wall Street classic and sits on the desk of many of the best traders in the world. The book is regarded as an essential read by such well known financiers as Ed Seykota, Paul Tudor Jones, and even former Fed Chairman Alan Greenspan.
Over the course of this guide we will look at Jesse’s best trading rules (as detailed in the famous book) and we will get right to the heart and strategy of the master trader.
1. Nothing new ever occurs in the business of speculating or investing in securities and commodities.
“Another lesson I learned early is that there is nothing new in Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again. I’ve never forgotten that.”
What Jesse means is that the same market moves and patterns occur over and over again. Markets are run by people, which means the same patterns will always occur. Throughout history we have seen the same speculative bubbles and market crashes time and time again. From the South Sea Bubble, to Tulip Mania, to the depression, to the 2008 credit crisis.
These crashes and bubbles are just an inevitable feature of the markets.
Sure, computers and algorithms play a much bigger part now but always remember that computer algorithms are built by humans in the first place. And often, when a major market event takes place, the computer programs are programmed to turn themselves off.
Jesse Livermore lived through the Great Depression and saw some of the most difficult trading conditions ever seen. Still, he was able to create massive fortunes trading volatility and trends.
Even if no day is ever the same, Jesse Livermore knew that markets and market patterns repeat themselves and investors act out the same behaviours year in year out. By recognising this, you can be start to believe in your ability to learn and adapt to the swings of the market.
2. Price moves along the line of least resistance.
“You watch the market — that is, the course of prices as recorded by the tape with one object: to determine the direction. Prices, we know, will move either up or down according to the resistance they encounter. For purposes of easy explanation we will say that prices, like everything else, move along the line of least resistance. They will do whatever comes easiest, therefore they will go up if there is less resistance to an advance than to a decline; and vice versa.”
This is probably the most important rule for any trader to learn. Because it really simplifies the entire trading process. It says, don’t think about the market too deeply, don’t over think things. The market will go where it wants to go and your best bet is to try and go with it.
Trading a security is always a battle between the bulls and the bears, so it doesn’t matter what you think about the market, if there aren’t enough buyers the market will go down and if there aren’t enough sellers the market is going to go up.
That’s how simple it really is.
Livermore’s talent was to watch the market for long enough until he had a feel for where the market would go next. He tried to get a feel for where the support was and where the resistance was. Or in other words where most of the buyers were and where the sellers were. If there were fewer buyers than sellers he’d look to go short, and if he thought there were more buyers he’d look to buy.
A good way to visualise this concept is to take a look at a short-term chart, like a 10, 30, or 60 minute. So take this chart of the euro dollar currency pair for example which is a 60 minute chart:
You can see how the price is constantly moving around. Buyers and sellers continuously fighting over control. Then at some point, one side will take over, and you’ll see the price shoot in one direction. In this case down, as euro sellers overpower the euro buyers.
In stocks, you can see the volume bar too, so when the buyers overpower the sellers the market shoots up and the volume bar is coloured green.
Stops get hit, traders revers positions and all of a sudden you see huge momentum. Traders will then latch on to this momentum and the trend will continue even further, meanwhile traders on the wrong side of the best will cut their losses, again exaggerating the trend further.
The market finds support and it goes up, it finds resistance and it goes down. It’s this constant meandering that takes place all the time in the markets.
The price takes the path of least resistance always.
3. Don’t try to catch all the fluctuations: This is a bull market
“I think it was a long step forward in my trading education when I realized at last that when old Mr. Partridge kept on telling other customers, “Well, you know this is a bull market!” he really meant to tell them that the big money was not in the individual fluctuations but in the main movements that is, not in reading the tape but in sizing up the entire market and its trend.”
In reminiscences of a stock operator Jesse Livermore spoke of an old and wise trader in the office called Mr Partridge, who they also called Old Turkey.
Old Turkey never traded off tips and he never handed out tips, but the other traders would often go to him to ask him on advice of what to do. But his reply would always be the same : This is a bull market, or, this is a bear market.
In other words, you have to always trade with the prevailing trend. You can’t try and catch all the fluctuations. If you do, you’ll go broke.
Here’s a monthly chart of the S&P 500:
You can see that the clear trend is up. This is still a bull market.
But you get so many traders trying to pick all the tops and bottoms. They want to sell here, buy here, sell here, buy here. Trying to buy into all of the dips and sell the tops.
But no-one alive can time the market like that, and if you try you just end up spending more and more on commissions and trading costs.
The solution is simple. If this is a bull market you should be long, if this is a bear market you should be short.
And as Mr Partridge used to say, once you sell your trade you lose your position. If you want to be long and you are long, never sell your position in order to buy it back on a reaction.
4. You don’t have to trade
“After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight!”
“Men who can both be right and sit tight are uncommon. I found it one of the hardest things to learn. But it is only after a stock operator has firmly grasped this that he can make big money.”
Money cannot consistently be made trading every day or every week during the year. So if you have losing periods, never feel too bad, because they will always come.
If you’ve got a winning trade, the best decision is often to do absolutely nothing and just sit tight.
As long as the stock is acting right, and the market is right, do not be in a hurry to take profits. That’s another direct quote by the way. Most of the time, you’ll make way more money just sitting tight and waiting for the trade to develop.
So never feel like you have to make a trade and never search for action in the market. Rather, let the opportunities come to you, so that when they are presented, the opportunity is so good you simply have to make the trade.
You can see this clearly in the chart. This one is for gold. There are plenty of days when an opportunity just doesn’t present itself.
Maybe it’s a public holiday or maybe there just isn’t any news on the calendar. You’ve got these tiny trading ranges, these small bars where there just isn’t enough price movement to make a profit.
When you trade these quiet days, it can be really frustrating because you’ll end up buying a breakout, selling a breakout but just getting chopped up.
So on days like these, when you think it’s going to be a quiet day in terms of trading, maybe there isn’t anything on the calendar, or maybe Europe is on holiday, then you want to really scale back your profit targets. Or even take the day off completely. Again, you’re going to save yourself money in the long run if you just wait for the opportunities to present themselves to you not the other way around.
5. Good trades move into profit quickly
For trend traders, unlike contrarian investors or mean reversion traders, the best trades often move very swiftly into profit. There’s a good reason for that, because you’re often buying into strength or selling into weakness. You’re often trading right after the point of least resistance so you’ll likely going to see that momentum continue for a period.
And you can see this, too, in countless charts, like this one for WTI crude oil. This is a weekly chart:
And you can see that once price breaks through an important level it will just go and go and go. If you were short when the key $90 level broke your position would have moved more or less straight into profit and it would have just kept moving down and down.
The best trades will often move straight into profit. So if you do trade a breakout and it pulls back, and you find that you’re waiting around, then that’s probably the first sign that you might have to cut your losses.
6: Practice makes perfect
The curious thing about trading is the old statistic that is always being mentioned about 95% of all traders losing money. And while there is truth to this statement it does not fully reflect the situation. Because, most of those 95% are not trading they are gambling. And if you set aside the minority of informed traders who are adequately capitalised and have learnt the discipline and skills needed to trade, then this statistic starts to change.
For these people (the informed traders) trading has become a craft and a way of life. When you reach this very high level, trading becomes not as difficult as people make out.
7. There is only one side to the stock market: the right side.
Jesse Livermore knew a lot about mistakes because he made several. He was a self-made man trading his own money and building a fortune but he lost a lot of money too. So every lesson he learnt he learnt the hard way.
Which is why, all this talk of whether you are bullish or bearish, it doesn’t matter all that much. You have to listen to what the market is telling you. And the right side is the side that the market is moving in.
Many commentators will say we’re about to move into a bear market or we’re about to see a bull market, but those predictions are useless until we are actually in it.
Take an example. In 2011, the stock market had risen nearly 100% from it’s 2009 low. Yet you still had some commentators saying that we were still in a secular bear market, and that the rally was a pullback from the long-term downward trend. Even today, there are some investors who claim we are still in a secular bear market.
These guys have been saying for years that we are still in a bear market. They’ve probably been trading the wrong side all this time and they continue to trade on the wrong side even though the market keeps rallying.
It’s a simple rule to master, which is to follow the market, don’t try to predict it. Be on the right side of every trade you place, long or short.
8. Don’t trade too large or risk too much
In reminiscences of a stock operator Jesse Livermore recalls a conversation between two friends where one of them can’t sleep at night because he was carrying so much cotton.
He had a huge position in cotton futures, too big than he could handle and this was causing him undue stress and panic, so much so that he had trouble sleeping at night.
You see, the problem is, if you trade too heavily every little movement in the security gives you undue stress. Which it wouldn’t normally.
And of course this will also depend on how much capital you have and how much you’re willing to lose.
When you trade too heavily, you risk blowing up your account and losing all of your trading capital. And if you trade on margin, and without stop losses, you can end up losing even more than you have in your account.
So one key sign that you’re trading too heavy is that you have difficulty sleeping and you feel jittery when you have a trade on. Every movement is amplified and it becomes difficult to make the right decision.
That’s why it’s better to keep risk small so you can sleep easily at night. Ed Seykota likes to say that you should trade small enough that you won’t go broke but large enough to make it worthwhile.
Most traders recommend using just 1% or 2% of your trading capital when you place a trade. But it will depend on the type of strategy you trade. So spend some time with your strategy and work out the risk level that works for you.
9. Other investors may be irrational
We have seen time and time again how investors have behaved in irrational ways and you only need to look at the various booms and busts to realise that the market is not efficient all of the time. You may even have observed this in your own trading. Maybe you sold a trade at precisely the wrong time, even though you knew it was the wrong thing to do. Or maybe you took your profits too early, even though your plan was to hold on for much more.
When investors are this irrational it is for the informed trader to take advantage. And one way to do that would be study the effects of behavioural finance, amongst other things.
10: You can’t tell till you bet
“Pat Hearne made money in stocks, and that made people ask him for advice. He would never give any. If they asked him point-blank for his opinion about the wisdom of their commitments he used a favorite race-track maxim of his: “You can’t tell till you bet.”
In the book, Jesse Livermore spoke a bit about a professional gambler called Pat Hearne.
Pat would treat the markets like a roulette or blackjack game and make a series of calculated bets looking for small, sure wins. He would sell whenever the stock dropped back by just 1 cent.
This was a sensible approach to trading that also had a big influence on Jesse Livermore and his trading rules.
In essence, Jessie realised that you can’t judge a market until you are in it. This is why Jesse would buy a little bit of the market first of all to test the water. If the trade felt good, and the stock moved as he liked, he’d add a little bit more, gradually building up a bigger and bigger line.
This is how you make the most amount of money from the big trends. If price follows the line of least resistance you go with it and keep building.
Of course, this is the opposite to what most traders do. Most traders accumulate shares on the way down. They see that their trade is losing money, but they still believe that they’re right, so they buy more and try and reduce their cost base. This causes them to average in to losses and they end up building a huge losing position that causes considerable pain.
The market is saying that it’s not ready to go in that direction and you can’t force it.
It’s much better therefore, to wait for the market to tell you where it wants to go. Jesse would always accumulate his position on the way up, often trading at brand new highs.
He’d start by buying one-fifth of his full line. If the market did nothing, then he’d wait. If it showed him a loss he’d get out and if it started to go up, he’d assume that he was trading in the right direction and he’d add another contract. If it went up again, he’d add a bit more and a bit more again and so on, slowly building up his full position.
“What I have told you gives you the essence of my trading system as based on studying the tape. I merely learn the way prices are most probably going to move. I check up my own trading by additional tests, to determine the psychological moment. I do that by watching the way the price acts after I begin”
This way you bet big only when you win, and when you lose, you only lose a small exploratory bet. Once the real move starts, and the big trend kicks in you can make the large profits extremely quickly and easily.
11. In a bear market all stocks go down and in a bull market they go up.
This is another problem that many traders have. Namely, they try and short stocks in a bull market or buy stocks in a bear market. And they forget that the most important thing is the overall trend in the market.
This is clearly visible in any chart that you can compare with the broader stock index. Try finding a stock that went up in 2008, for example and you will have a very difficult job. Likewise, try and find a stock that went down in the fierce bull market of 2009 and you will have a lot of trouble.
There is incredibly high correlation between all stocks. And that correlation gets even stronger during a significant market event like a crash.
In fact, during extreme market events, it’s not just stocks that all go down, nearly all markets can go down together.
In the 2008 crash, we saw stocks, commodities, real estate, gold all go down together. The only markets left standing were safe havens like US treasuries and the US dollar. But it won’t always be like that, because every situation is different. Next time we might well see a situation where the US dollar goes down as well.
But the key point is to know the type of market you’re in. Is this an early stage bull market, or a maturing bull market. Or are we in a bear market or ranging market?
There’s little point attempting to short stocks in a bull market and there’s little point buying stocks in a bear market. It doesn’t matter which individual stocks you’re talking about, it’s just a bad strategy.
And on a similar note, Jesse would say that you should look for the main stocks that are leading the market. And if you can’t make money out of the leading active issues, you are not going to make money out of the stock market as a whole.
So think about which stocks are being heavily traded, which are moving the most and making all the headlines. These are often the best stocks to focus on for trend traders, as they show the best movement. And if you can’t make money on these leading stocks, then chances are the overall market might be deteriorating, and if that’s the case you should probably reduce your exposure and size.
Having said that though, Jesse would say that you should never become completely bearish or bullish on the whole market just because one stock – in some particular – has plainly reversed. Even if it is one of the leading issues.
It just isn’t enough to suggest any omen for the future. There are any number of reasons why the stock may have moved and you can’t make a judgement on the whole market by the actions of one individual stock.
12. In a narrow market wait for a break-out
“In a narrow market, when prices are not getting anywhere to speak of but move within a narrow range, there is no sense in trying to anticipate what the next big movement is going to be. The thing to do is to watch the market, read the tape to determine the limits of the get nowhere prices, and make up your mind that you will not take an interest until the prices breaks through the limit in either direction.”
Jesse Livermore was an expert at reading the tape. Gauging market sentiment and predicting where the market might head next.
In a bull market, the best place to be is already long and in a bear market the best place to be is already short.
But, of course, markets sometimes consolidate and they go sideways for periods. During these times, the market range can narrow, price action can get choppy. And when that happens, the best plan of action is to just sit back and watch.
These are not good periods for trend traders so it’s useful to look around for different markets to trade. Trends do not always occur, and perhaps they only occur 30-40% of the time. However, you can always find a market somewhere that is trending.
Again, we can see this clearly on the charts.
The S&P 500 has been in a trading range for most of 2015, so has the Dow, so has the Nasdaq and so have most of the European stock markets.
GBP/USD has been in a range, silver has been choppy and so has the euro.
But there are plenty of markets that have been trending. Coppers has been trending down steadily, platinum has been trending down, and the US dollar has been trending up. Amazon has been going higher and higher.
One of the tricks is to find the best trending markets and join them on their journey.
So if you have a range trading market, it’s actually a good opportunity, because you know where the breakout can happen.
So the range trading markets are good to keep an eye on. You can watch them, plan your trade and wait for an explosive breakout.
13. Never argue with the tape
“I don’t know whether I make myself plain, but I never lose my temper over the stock market. I never argue with the tape. Getting sore at the market doesn’t get you anywhere. Markets are never wrong, opinions often are.”
There are many traders who take out their losses and negative emotions on the market itself, which, when looked at objectively, is ridiculous.
Traders treat the market as if it is human, as if it has a personality. But of course it has neither.
If you get stopped out of a trade and you show a loss, or if the market doesn’t act how you expected it to, it is not the market’s fault. The market isn’t wrong. The market is never wrong, only opinions can be wrong.
Some traders might think that we have hit a short-term top in the stock market, some might think that oil is far too low at this price. Some might say that gold is forming a bottom and will soon rally to new highs.
But the truth is that the market will go where it has to go. Only the market can prove who is right and who is wrong.
If you follow the trend and forget about making predictions, just follow prices, you can stop blaming the market and just go with the flow. You’ll stop being angry at missed trades and you’ll trade in a much more relaxed and effective way.
You just need to watch the tape and act accordingly. Never fight the tape.
14. Hope for profits and fear losses
If there is one rule that is key for following trends in the market it’s this. It’s the equivalent to cutting losses short and letting winning trades run. That’s how you let trends develop and how you build the big profitable positions.
So when you place a trade, and maybe you start off with just a small position, you want to fear that that trade will turn into a small loss. You fear losses and if they occur you cut your position and you wait for another opportunity.
On the other side, you place a trade and you hope for the market to go your way. And you want to hope that it keeps going and going in your direction, allowing you to build your position and keep making money.
The profits available from long term trends are frequent enough to provide plenty. You can see it on almost any chart. Look at the huge bull markets in stocks, between 2009 and 2015 and in the 1990s and 1980s. Look at the huge 30-year bull market in bonds. The long trends in currencies and commodities.
If you fear losses and hope for more profits, you’ll be acting in the right way.
15. Don’t trade for the thrill
“The desire for constant action irrespective of underlying conditions is responsible for many losses on Wall Street even among the professionals, who feel that they must take home some money every day, as though they were working for regular wages. Remember this: When you are doing nothing, those speculators who feel they must trade day in and day out, are laying the foundation for your next venture. You will reap benefits from their mistakes.”
Once you realise the cost of trading and the benefits of being able to sit tight in a market you learn a valuable lesson.
Once you’ve learnt this lesson, you can look at all the other investors on Wall Street and realise how they are actually helping you in your quest.
They’re all trading in and out of the market, every day racking up huge commission fees and losing money. This reveals the opportunity for you to take advantage of. By sitting on your hands and waiting for the profits to roll in, by only making calculated bets.
Always trade according to the trend and according to your plan.
The desire for action will be strong but you need to resist. Because that is the gambling mindset. The professional trader mindset simply sits tight and waits for the opportunities to come to him.
Remember that when you trade, you don’t only pay a fee to your broker and a commission but you pay the spread too.
“There is the plain fool, who does the wrong thing at all times everywhere, but there is the Wall Street fool, who thinks he must trade all the time. No man can always have adequate reasons for buying or selling stocks daily–or sufficient knowledge to make his play an intelligent play.”
The Bid:Ask spread, means that you can only buy at the best ask price (slightly above the market) and only sell at the best bid price (slightly below the market).
It is this spread that makes money for the market maker but it works against you every time you trade, so that every time you trade you start out with an inevitable small loss.
This is the cost to trade and to overcome it you first need to stop trading for action alone. Trade the trends and wait for the opportunities. There is always an opportunity around the corner.
16. Don’t listen to tips
“If I buy stocks on Smith’s tip I must sell those same stocks on Smith’s tip. I am depending on him. Suppose Smith is away on a holiday when the selling time comes around? A man must believe in himself and his judgement if he expects to make a living at this game. That is why I don’t believe in tips.”
Jesse Livermore didn’t believe in tips and neither should you. For a number of reasons. You should do your own research, do your own analysis and only take trades according to your own plan.
First of all, you don’t want to take a tip from a broker, because a broker might have a conflict of interest. A broker, for example, wants you to trade as often as possible. She wants you to keep trading in and out because that’s how she earns her commission.
So, the ideal customer for a broker is someone who trades all the time but doesn’t go broke. Plus, if your broker was that good at trading, she would be a professional trader instead of being a middle-man/woman.
Second of all, if you get a tip from someone, you have no idea what their intentions are. That person may have bought the stock at a much lower level, or they may have already hedged it with another trade. They probably haven’t told you about their exit strategy either and if they go awol you’ll be stuck with a position you don’t know what to do with.
So this is another timeless piece of advice. Never follow tips or rely on anyone else to do your trading for you.
17. Never be afraid to take a loss
“Losing money is the least of my troubles. A loss never troubles me after I take it. I forget it overnight. But being wrong – not taking the loss – that is what does the damage to the pocket book and to the soul.”
Jesse Livermore’s biggest mistakes, the ones that caused him to lose thousands and millions of dollars in profits, did not come from taking the wrong trades or from taking small losses, they came from not taking a loss when it was still small.
In other words, by leaving the loss and not cutting it short, the loss was able to grow and grow, until it was too big and too painful to let go of. Those are the decisions that cause huge losses to capital and confidence.
Jesse goes on and talks about two trades he had, one in wheat that showed a profit and one in cotton that showed a loss. Like many traders, he took the profit in wheat but held the loss in cotton hoping it would turn around. But of course, it did the opposite.
The wheat kept on going in the right direction and would have made an even bigger profit. While the cotton kept dropping and the loss just got larger and larger.
“I did precisely the wrong thing. The cotton showed me a loss and I kept it. The wheat showed me a profit and I sold it out. Of all the speculative blunders there are few greater than trying to average a losing game. Always sell what shows you a loss and keep what shows you a profit.”
So it’s clear. Never be afraid to take a loss, especially when the loss is small and the trade is not working out. Abide by this simple rule and hold your winning trades for longer than your losing ones.
18. Wait for price action to confirm your opinion
“Don’t take action with a trade until the market, itself, confirms your opinion. Being a little late in a trade is insurance that your opinion is correct. In other words, don’t be an impatient trader.”
Often, traders get cocky.
They think they have the market figured out and they know what it’s going to do next. Maybe they’ve done a few hours of research and they’re convinced the market’s about to rally. Then they go ahead and trade straight away. They’re impatient and greedy. They want the market to do as they say, and they want to squeeze out every last cent.
But the market doesn’t behave that way. It goes where it goes and when you force a trade you end up on the losing side.
It’ far better to wait for the price action of the market to confirm your prognosis.
If you think the market will rally, then wait for it to go up a little, and then you can get in. If you think the market will fall, then wait for a signal first. Being a little late will cost you a few extra points but that will be nothing if you’re able to capture the much larger trend. And it will prevent you from trading in too many choppy, whipsawing markets.
Another thing traders do is they get fearful and impatient.
They see that the market is inching up to a breakout point and they convince themselves that the market is so strong that it will break through with ease. They then think that it would be a good idea to buy just before the breakout. That way they’re going to get into the trend a couple of points early and that will save them money.
Of course, this strategy is the wrong one. Because all too often, the market will inch right up to the breakout point and then it will fall back. It’s this resistance that causes there to be a channel in the first place. It’s waiting for the price action to confirm the trade that will lead to the biggest trends and the biggest profits.
19. Never average losses
We have spoken already that it’s important to cut losses short and let profits run and to never be afraid to take losses.
But it’s equally important to drill home the point that you should never average losses either.
Averaging losses simply means adding to a losing trade.
So, for example, say you bought $1000 worth of stock at a price of $10 a share and that stock then falls to $8. You’re currently down 20% and showing a loss of around $200.
Well, some traders will buy again to average down their entry price. So let’s say you buy another $1000 worth at $8. So you’ve now got $2000 invested at an average price of $9. So now your break even price has changed to $9 per share.
This sounds ok in theory but this is a concept that has led to thousands of blown accounts and millions of dollars of losses.
Because once a stock falls to $8, it’s just as likely to keep falling, and if you keep averaging in, your losses will grow larger and larger.
In fact, it was this kind of approach that led to the collapse of Barings Bank caused by rogue trader Nick Leeson.
The easiest way is to trade with the trend, you add to winning positions not losing positions and this means you manage your risk along the way instead of increasing risk and going against the trend of the market.
20. Don’t try and pick the turns
“One of the most helpful things that anybody can learn is to give up trying to catch the last eighth – or the first. These two are the most expensive eighths in the world. They have cost stock traders, in the aggregate, enough millions of dollars to build a concrete highway across the continent.”
If you want to try and pick the turns successfully you’re going to have a lot of difficulty and you’ll experience a very low win ratio. Simply because it’s almost impossible to pick the turns precisely and come out ahead.
If you trade this way you might lose 9 times out of 10 and undergo a lot of stress and pain in the process.
The easier way is to do what Jesse Livermore did and that is to forget about picking the turns. Don’t even think about looking for the tops or the bottoms. As Jesse Livermore says, the first and the last eighth are the most expensive in the world.
It is far easier to wait for a stock to turn and then catch it as it is already going up. Likewise, once a market has peaked and has already turned down, that’s the time to short it. You wait for the trend to turn in your favour, so that you are sure that the momentum has changed and then you go with it.
In this way, you always buy into strength and you always short into weakness.
This almost goes against human nature but it’s the way trend traders make their money.
21. Prices are never too high to begin buying or too low to begin selling.
If you take the time to look over any stock, you’ll find that prices trend, that is a fact of the markets that you can rely on. And it’s a principle that trend traders have been taking advantage of for years.
And you can just go through any number of charts to see that this is the case.
Effectively, trend traders can ignore the exact price levels. They simply must focus on the direction of the trend and the strength of the momentum. Finding a strategic way to follow these trends is perhaps the most useful path to take.
So, you should never avoid a stock because the price looks too high or too low. If you do that, you’re bound to miss out on some of the biggest multi-week trends.
Take a look at a stock like Apple. You can see on a long-term daily chart that this is a stock that has made literally thousands of new highs. Here’s the stock on a monthly chart which shows the extent of the price rise:
If you thought the stock was too high in 2010, you’d have been kicking yourself in 2011. And if you thought the stock was too high in 2011, you’d be cursing yourself in 2012. And so on. If you never buy a stock when it’s making new highs you’re likely going to miss out on all of these big potential gains.
Along the same lines, once you buy a stock, don’t just sell it because it looks high-priced. As we’ve seen with Apple and other examples, the stock can keep going up and up and up. Rather, it’s better to wait for the trend to change, so the correct time to sell is when the stock has turned downwards.
Likewise, you shouldn’t buy a stock after it has declined from it’s previous high. At least not without testing the strategy thoroughly first.
This is one of the biggest mistakes for beginning trend followers. Instead of buying a stock or security at a new high, they wait for the market to pull back. But this doesn’t work too well a lot of the time.
All too often, the best trades will never offer you another opportunity to get in at a lower price, so you have to take the trade when it first appears.
The trades that do pull back and give you a chance to buy in, those are often the ones that keep going south after you’ve made the buy. They’re often the bad trades. They’re among the 60% of trend trades that typically fail.
There’s usually a fundamental reason why the stock has fallen and that’s why it will probably keep going lower or trading sideways for an extended period.
22. It is not good to be too curious about all the reasons behind the price movements.
“you must have an open mind and flexibility. It is not wise to disregard the message of the tape, no matter what your opinion of crop conditions or of the probable demand may be. I recall how I missed a big play just by trying to anticipate the starting signal.”
In my opinion, this is another key rule and statement from the master trader, Jesse Livermore.
You shouldn’t get caught up trying to understand why a market is doing what it’s doing.
The financial news, reported on sites like Bloomberg and CNBC, will always have a reason for why the market did this and why the market did that, but 90% of the time these reasons are just made up statements, made after the fact.
Financial reporters have a job to do, which is to report on the market. Every single day.
Even when the S&P 500 has finished exactly where it started, a reporter at Bloomberg will discuss the day’s events and find some reason for why the market did what it did.
For example, the other day the S&P 500 went up by 0.56%. According to Bloomberg News, this was due to a better than expected housing number and some potential merger discussions in the technology space.
But is this the real reason why the market went up today?
Most likely, the answer is no. A more accurate answer would be that the market went up today because there were more buyers than sellers over the duration of the session. The market is essentially pretty random on any given day and it follows the path of least resistance.
But of course, you cannot repeat this kind of statement every day because no-one would read it. It’s extremely dull. So reporters must think of ways to explain the movement.
But as I said, 90% of the time, you cannot fully explain daily price movements. Therefore it pays to largely ignore the financial news. This is especially true on quiet days when there are very few important economic releases.
You should also stay flexible when you do have a trade. Because you cannot think too deeply about the underlying issues or you will likely stay with a trade too long or get out too quickly.
I’m not saying that you can never explain market moves. Some of the time, there will be a major event that you can explain. 100%.
For example, the Swiss Franc didn’t soar 30% in January for no reason. It did so because the Swiss National Bank took away the exchange rate peg to the euro.
And the stock market didn’t drop 40% in the 2008 bear market for no reason. It fell because the financial system was in danger and the global economy was moving into a deep recession.
But even though these major market events can be explained, it does not follow that you can easily predict them.
Even if you can predict them, timing them becomes the next biggest hurdle.
For instance, there were many smart people who predicted the 2008 crisis. Commentators like Jim Rogers, Nouriel Roubini, Marc Faber, John Paulson and many others all knew that the property market was forming a bubble and that the banks were over-leveraged.
But few were able to time the bear market well enough in order to take full advantage. Jim Rogers had been bearish on the market since around 2004, so it took years before the market finally proved that he was right. John Paulson made billions betting against risky mortgages, but he had to endure at least a year of lacklustre returns before the majority of his winnings came to fruition.
So, in general, you may be able to explain the larger market moves but predicting them and timing them is a completely different matter.
When it comes to daily, short-term movements, there is almost no way to predict what happens. Unless you can gain access to the complete order book that shows how traders are buying and selling and even then it is not easy because of dark pools.
Just remember that the market will always take the path of least resistance, so don’t think too deeply about why it is doing what it’s doing. Just remember to go with the flow. Keep your risk managed and place your bets according to the trend and your plan.
23. Don’t be controlled by your emotions.
In trading, there are possibly three things that are most important. The direction of the trend, conservative risk management, and psychology.
The direction of the trend tells you how to bet. And your money management rules should tell you how much to bet. But psychology is the final piece of the puzzle that makes everything come together.
Because if you don’t have the right mindset in the first place, you’ll find it extremely hard to follow trend trading rules.
The trend trading philosophy or concept is one that has shown to be successful over many years. But the difficulty is that it does not always sit well with the human mind.
First of all, correct trend trading tells you to go against what comes naturally.
Instead of buying a market when it has pulled back and looks cheap, you must buy when the market is strong and looks expensive. And you must short when it is weak and almost looks as though it couldn’t go any lower.
And instead of selling a stock near it’s high, when you’re making a nice profit, you must wait for it to turn around and to start going the other way. In effect, potentially giving up some of your profits.
And when you have a losing position, instead of waiting for that position to get to break-even or make a small profit, you must take the loss, cut it short and look for a new opportunity.
Of all the problems associated with trend trading, cutting losses short and letting winning trades run is perhaps the most difficult for traders to overcome.
Because there is scientific evidence into the human mind that shows how investors fear losses by a much greater margin than they enjoy winnings.
According to Daniel Kahneman, we fear loss twice as much as we relish success and this makes it hard for us to take risks.
In trading, this means that we will do anything to avoid taking a loss. But this doesn’t work for trend following, because successful trading of trends entails taking many small losses, all the time, and paying for them with a few, much bigger winning trades. If you don’t do this, your loss will turn into a bigger loss and your winning trades won’t be given the room to turn into huge profits.
This is the psychological lesson that Jesse Livermore’s trading rules teach and which all trend traders must learn.
Fear will stop you from cutting your losses early and it will make you take your profits too quick. Once you can realise this, you will be on your way to successful trend trading, and aligning yourself with the natural ebb and flow of the markets.
And, human impulses can work against you in other ways too.
For example, another way is how we handle boredom. As humans, we dislike boredom, we like to keep busy and we like to work hard for our money. But again, this can work against us in trading. Because if you’re bored, you are more likely to trade, and you’re more likely to seek out trades rather than letting them come to you.
By trading too much, you spend too much on commissions and you lose money. So again, successful traders must ignore their human impulses to trade too much or all the time.
“It sounds very easy to say that all you have to do is to watch the tape, establish your resistance points and be ready to trade along the line of least resistance as soon as you have determined it. But in actual practice a man has to guard against many things, and most of all against himself — that is, against human nature.”
Overall, if you have problems with this third component, psychology, you will find it hard in the markets. Jesse Livermore paved the way, winning and losing many millions and he learnt the hard way that the human mind is your greatest asset and greatest enemy.
But you can teach yourself discipline and learn to ignore your human impulses. With time, you can start to trade with a clear and logical mindset, one that follows the trend following maxim.
24. One should never permit speculative ventures to run into investments.
Once you make a trade, you should know your motives. If you’ve made a speculative play as Jesse suggests, don’t let that trade turn into a long-term investment.
If the trade is doing poorly, it’s not wise to say that this is now a long-term investment so it doesn’t matter how low it goes. There is simply no reason to keep a trade open that is not performing. This is the trend following mantra. Trades that start poorly usually keep performing badly and just lead to bigger and bigger losses.
Even if the trade is doing well and it’s making money, it will still turn around and when it does, the trend trader needs to be alert to close out the position and move on to another.
This is just another famous trend trading rule which can also be referred to as ‘never get tied to a stock’. Don’t fall in love with a stock just because it’s gone up a few percent.
Don’t become emotionally involved. As Jesse says, more money has been lost by investors letting their investments ride than anything else.
25. Avoid get-rich-quick schemes.
“The sucker has always tried to get something for nothing, and the appeal in all booms is always frankly to the gambling instinct aroused by cupidity and spurred by a pervasive prosperity.”
Jesse Livermore realised early on that a fool and his money is easily parted and especially so during boom years and bull markets. During these periods people become curious about making money, they become greedy and complacent. They think that markets can only go up and never down and are even told this by various commentators and publications. The 2007 housing crisis, where investors believed that house prices could not fall, was a prime example of this.
Jesse Livermore Trading Rules: Conclusion
I hope you have enjoyed this look into Jesse Livermore, his trading rules and strategies. For some, the suggestions and ideas on this page may appear too simplistic.
But personally, I don’t believe this to be the case. From years of trading it’s clear to me that the best traders are those who are able to find the trends and follow them, just as Jesse Livermore used to do.
As Jesse said, nothing changes on Wall Street and I’ve found that simple techniques work just as well as they ever have.
Many of the best traders do not use complicated strategies, systems or techniques. They simply follow the trends. This sounds simplistic but it isn’t easy because good trend following entails working against your natural human instincts.
Once you know how to find trends and you know how to manage risk, it is the ability to control your psychology that will determine whether or not you can beat the market. If you can do that, you can trade like Jesse Livermore did, and you can have fun taking down the biggest trends.
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Thank You For Reading
Joe Marwood is an independent trader and the founder of Decoding Markets. He worked as a professional futures trader and has a passion for investing and building mechanical trading strategies. If you are interested in more quantitative trading strategies, investing ideas and tutorials make sure to check out our program Marwood Research.
This post expresses the opinions of the writer and is for information or entertainment purposes only. It is not a recommendation or personalised investment advice. Joe Marwood is not a registered financial advisor or certified analyst. The reader agrees to assume all risk resulting from the application of any of the information provided. Past performance, historical or simulated results are not a reliable indicator of future returns and may not account for real world settings. Financial trading is full of risk and margin trading can lead to financial losses totalling more than what is in your investment account. We take care to present accurate analysis but mistakes in backtesting and presenting of analysis regularly occur. Please read the Full disclaimer.
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