Have you got something to say about Jesse Livermore / stock investing?

I won’t have too much time to put together my own blog posts over the next few weeks so I thought it would be fun to get some views, analysis and opinion other than my own.

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On October 24 1907, Jesse Livermore made his first $1,000,000.

Summer 1907, Jesse had sailed to France. His account balance stood at three-quarters of a million dollars, made shorting the markets. Here’s how, in Reminiscences of a Stock Operator, Jesse Livermore describes how he made his first million dollars

Vacation Time
“I was in Aix-les-Bains enjoying myself. I had earned my vacation. It was good to be in a place like that with plenty of money and friends and acquaintances and everybody intent upon having a good time… Wall Street was so far away that I never thought about it… I didn’t have to listen to talk about the stock market. I didn’t need to trade. I had enough to last me quite a long time, and besides, when I got back I knew what to do to make much more than I could spend in Europe that summer.”

Jesse Livermore Smells Market Manipulation
“One day I saw in the Paris Herald a dispatch from New York that Smelters had declared an extra dividend. They had run up the price of the stock and the entire market had come back quite strong. Of course that changed everything for me in Aix. The news simply meant that the bull cliques were still fighting desperately against conditions - against common sense and against common honesty, for they knew what was coming and were resorting to such schemes to put up the market in order to unload stocks before the storm struck them.”

Insiders Begging To Be Shorted
“At all events, I knew that all bull manipulation was foredoomed to failure in that bear market. The instant I read the dispatch I knew there was only one thing to do to be comfortable, and that was to sell Smelters short. Why, the insiders as much as begged me on their knees to do it, when they increased the dividend rate on the verge of a money panic. It was as infuriating as the old “dares” of your boyhood. They dared me to sell that particular stock short.”

Livermore Starts Selling Smelters Short
“I cabled some selling orders in Smelters and advised my friends in New York to go short of it. When I got my report from the brokers I saw the price they got was six points below the quotations I had seen in the Paris Herald. It shows you what the situation was. My plans had been to return to Paris at the end of the month and about three weeks later sail for New York, but as soon as I received the cabled reports from my brokers I went back to Paris. The same day I arrived I called at the steamship offices and found there was a fast boat leaving for New York the next day. I took it. There I was, back in New York, almost a month ahead of my original plans, because it was the most comfortable place to be short of the market in. I had well over half a million in cash available for margins.”

Livermore’s Shorting Gains Momentum
“From the latter part of September on, the money market was megaphoning warnings to the entire world. But a belief in miracles kept people from selling what remained of their speculative holdings… Things got worse and worse. Finally there came the awful day of reckoning for the bulls and the optimists and the wishful thinkers and those vast hordes that, dreading the pain of a small loss at the beginning, were now about to suffer total amputation—without anaesthetics. A day I shall never forget, October 24, 1907.”

Livermore’s Conscience Kicks In - And An Instinct For Profit
“I had enormous paper profits and the certainty that all that I had to do to smash prices still more was to send in orders to sell ten thousand shares each of Union Pacific and of a half dozen other good dividend-paying stocks and what would follow would be simply hell. It seemed to me that the panic that would be precipitated would be of such an intensity and character that the board of governors would deem it advisable to close the Exchange.

“It would mean greatly increased profits on paper. It might also mean an inability to convert those profits into actual cash. But there were other things to consider, and one was that a further break would retard the recovery that I was beginning to figure on, the compensating improvement after all that bloodletting. Such a panic would do much harm to the country generally. I made up my mind that since it was unwise and unpleasant to continue actively bearish it was illogical for me to stay short. So I turned and began to buy. It wasn’t long after my brokers began to buy in for me— and, by the way, I got bottom prices—that the banker sent for my friend.

No Longer a Gambler, but an Intelligent Trader
“I came out of it in fine shape. The newspapers said that Larry Livingston, the Boy Plunger, had made several millions. Well, I was worth over one million after the close of business that day. But my biggest winnings were not in dollars but in the intangibles: I had been right, I had looked ahead and followed a clear-cut plan. I had learned what a man must do in order to make big money; I was permanently out of the gambler class; I had at last learned to trade intelligently in a big way. It was a day of days for me.”

I don’t write too often about recent market action. Jesse Livermore liked to say that speculation was as old as the hills and I’ve tried to make most of my writing here “timeless” rather than “market commentary”.

I thought though, given the scale of the sub-prime problems, I would look at two of the best known stocks that have suffered in the crisis and how Jesse Livermore’s trading rules would have kept anyone who uses them out of trouble.

I’ll mention in passing that a senior contact I have at a well-known investment bank has tipped me that his own company has suffered enormous losses in debt instruments this year.

Like all the tips I get, I’ll not make much use of it – other than to pass it on here. After being stung once too often, Jesse Livermore learned not to act on inside tips – he found that acting on price and volume data was more profitable than acting on tips. Furthermore, although my contact’s bank hasn’t yet announced its losses, several others – such as UBS and Citigroup have.

So how would Jesse Livermore’s rules have kept us out of trouble?

Livermore’s number one trading rule was:

Buy rising stocks and sell falling stocks.

So let’s have a look at two of the highest profile stocks to have suffered in the US and UK stock markets recently.

Firstly, there’s the Northern Rock Bank in the UK – the only UK bank in living memory to have suffered a run, as customers queued for hours to get their money back. Here’s Northern Rock’s price chart from Yahoo Finance. There has been a clear downward trend for a considerable time and so – according to Livermore - the stock has been a clear SELL for some time. Selling sooner rather than later would have protected investors from the recent price collapse.

Northern Rock Chart 2007

Secondly there’s Countrywide Financial Corporation in the US. Again there has been a clear downward trend for a considerable time and so the stock has been a clear SELL for some time.

Countrywide Chart 2007

What’s interesting is that credit ratings agencies continued to give healthy credit ratings to companies which have run up against severe liquidity problems. The agencies’ analytical skills were unequal to the task of measuring the risks in the sector. In other words, while fundamental analysis continued to point to the financial health of many finance companies, the market itself was taking a less rosy view and stock prices had been trending downwards.

Jesse Livermore’s trading rule is as valid today as it was one hundred years ago:

Buy rising stocks and sell falling stocks.

“I knew the market was going to take a hit, I just shorted it too early.”

I’ve heard too many traders say this – or something like it.

If you’re a member of the “I was right but my timing was wrong” crowd, think about these examples:

1. “I told everyone that the sun was rising in London. If I’d waited just another three hours, I’d have been right.”

2. “I told my friend I’d catch the afternoon flight. If I’d reached the airport by 3pm, I’d have been right.”

3. “I predicted a Democrat would win the election. If I’d waited eight years, I’d have been right.”

I was right but my timing was wrong. Better just say, I was wrong.

After taking a big loss on one occasion, Jesse Livermore said of his error:

“I didn’t wait to determine whether or not the time was right for plunging on the bear side. On the one occasion when I should have invoked the aid of my tape-reading I didn’t do it. That is how I came to learn that even when one is properly bearish at the very beginning of a bear market it is well not to begin selling in bulk until there is no danger of the engine back-firing.”

Jesse is saying that if you don’t get both the direction and the timing of the trade correct, then you’re wrong. You should only take a position after the market direction has been confirmed.