Jesse Livermore described the emotions of hope, greed and fear at various times as:

* The speculator’s chief enemies
* His natural foes
* The speculator’s deadly enemies

Livermore’s views on hope and fear lie at the heart of successful trading. He describes how traders fail when they allow hope of recovery to prevent them cutting their losses and fear of losing a small profit to make them sell prematurely, when more profit would have been available if only they had the nerve to stick with the trend.

“The speculator’s chief enemies are always boring from within. It is inseparable from human nature to hope and to fear. In speculation when the market goes against you you hope that every day will be the last day—and you lose more than you should had you not listened to hope….

“And when the market goes your way you become fearful that the next day will take away your profit, and you get out—too soon. Fear keeps you from making as much money as you ought to. The successful trader has to fight these two deep-seated instincts. He has to reverse what you might call his natural impulses.

“Instead of hoping he must fear; instead of fearing he must hope. He must fear that his loss may develop into a much bigger loss, and hope that his profit may become a big profit.

AND

“I am fairly immune from the commoner speculative ailments, such as greed and fear and hope. But being an ordinary man I find I can err with great ease.”

AND

“The speculator’s deadly enemies are: Ignorance, greed, fear and hope. All the statute books in the world and all the rules of all the Exchanges on earth cannot eliminate these from the human animal. Accidents which knock carefully conceived plans sky-high also are beyond regulation by bodies of coldblooded economists or warm-hearted philanthropists. There remains another source of loss and that is, deliberate misinformation as distinguished from straight tips. And because it is apt to come to a stock trader variously disguised and camouflaged, it is the more insidious and dangerous.”

How Important is all this?
What I’m talking about here is probably the most important aspect of trading. If you can control your emotions during trades, you have a good chance of success. If you can’t, you’ll almost certainly fail.

Quick Thinking

Christian Siva-Jothy was Head of Proprietary Trading with Goldman Sachs. (Prop trading is when firms trade for themselves rather than on behalf of customers for fees.)

Siva-Jothy made his name on seemingly high-risk trades he made in the immediate wake of the first airliner crash into the World Trade Center in 2001.

“The first thing I noticed on the TV was that it was a perfectly clear blue sky day. I’m a helicopter pilot and I’ve been flying for 14 years. I know that when you’ve got a plane that’s going down, you don’t aim for the tallest building to fly into.

“I immediately thought, ‘terrorist act’. I figured this was going to whack consumer sentiment… I bought Eurodollars…

Markets can be Unbelievably Slow to React

“Strangely, I think they rallied no more than 13 basis points on the day. Markets can be unbelievably slow to figure out the consequences of big events.”

The capacity of markets to react slowly to events was also noted by Jesse Livermore, who said:

“The Street paid no attention to the earthquake the first day or two. They’ll tell you that it was because the first dispatches were not so alarming, but I think it was because it took so long to change the point of view of the public toward the securities markets. Even the professional traders for the most part were slow and shortsighted.”

Christian Siva-Jothy’s Favorite Book - Reminiscences of a Stock Operator

Interestingly enough, it turns out that Christian Siva-Jothy is well acquainted with Jesse Livermore. When asked – by Steven Drobny, in The House of Money – “Are there any books that you recommend to your traders,” Siva-Jothy responded:

“My favorite book in relation to markets is Reminiscences of a Stock Operator, by Edwin Lefèvre. I’ve probably read it four or five times, and I love it every time I read it. He talks about everything, about risk, about hubris, about passion, everything.”

I thought I’d make a quick post to commemorate the fact that it’s 130 years since Jesse Livermore was born.

Although his family might have given him birthday presents, Jesse Livermore never expected the stock market to be so generous. He said:

“I could build a huge hospital with the birthday presents that the tight-fisted stock market has refused to pay for.”

He wasn’t speaking only of himself. He was expressing his concern for people who trade with a view to buying something nice with trading profits.

“In fact, of all hoodoos in Wall Street I think the resolve to induce the stock market to act as a fairy godmother is the busiest and most persistent.

“There isn’t a man in Wall Street who has not lost money trying to make the market pay for an automobile or a bracelet or a motor boat or a painting.

“Like all well-authenticated hoodoos this has its reason for being. What does a man do when he sets out to make the stock market pay for a sudden need? Why, he merely hopes. He gambles. He therefore runs much greater risks than he would if he were speculating intelligently, in accordance with opinions or beliefs logically arrived at after a dispassionate study of underlying conditions.

“To begin with, he is after an immediate profit. He cannot afford to wait. The market must be nice to him at once if at all. He flatters himself that he is not asking more than to place an even-money bet. Because he is prepared to run quick—say, stop his loss at two points when all he hopes to make is two points—he hugs the fallacy that he is merely taking a fifty-fifty chance. Why, I’ve known men to lose thousands of dollars on such trades, particularly on purchases made at the height of a bull market just before a moderate reaction. It certainly is no way to trade.”

Happy Birthday Jesse

Jesse Livermore was one of the world’s most famous (or infamous) stock traders.

Now, almost 80 years after his fame peaked, many people still regard him as one of the greatest stock traders ever. With this in mind, here are some ways of assessing how deeply you’ve come under the influence of Jesse Livermore.

You know you’re under Jesse Livermore’s spell when:

• You tell anyone who’ll listen that “there is nothing new in Wall Street”.
• You forget everything you’ve ever learned about position sizing and put all of your own money (and ten times more from your broker) into a single trade.
• You tell people, “never argue with the tape”.
• You tell your (male) children to keep their cash close to their balls and never let anyone near it.
• You start talking about the size of the line you’re swinging.
• You have your best ideas while big-game fishing off the coast of Florida.
• You often begin sentences with the words “There I was…”
  • “There I was, once more broke, which was bad, and dead wrong in my trading, which was a sight worse.”
  • “There I was, short five thousand shares of Union Pacific on a hunch.”
  • “There I was on the morning of May ninth with nearly fifty thousand dollars in cash and no stocks.”

You know your wife’s under Livermore’s spell when:

• She starts paraphrasing his famous dictum “A stock can never be priced too high to buy” – but replaces “stock” with “necklace”, “shoes”, “dress”, “designer kitchen”, “bathroom suite”, or “vacation”.
• She repeatedly tells you, “there is nothing new in Wall Street my wardrobe”.
• She forgets everything you’ve ever told her about position sizing and puts all of your money (and ten times more from your bank) into her dream house.
• She tells you, “never argue with the tape me”.
• She often begins sentences with the words “There I was…”
  • “There I was, embarrassed because everyone else was better dressed than I was.”
  • “There I was, the only one not having an overseas vacation this year.”
  • “There I was, the only one whose husband hadn’t come too.”

Long term investors - Warren Buffett is the best-known example - prefer to leave their money in the markets to reap the rewards of compounding.

Jesse Livermore - a trader - thought this was unwise. His opinion was that, after a successful trade, traders “should make it a rule to take one-half of the profits and lock this sum up in a safe deposit box.”

In How To Trade In Stocks Jesse Livermore describes how he was staying in Palm Beach after a highly successful trade. He requested the telegraph operator to tell his broker in New York to deposit one million dollars from the trade into his bank account. After sending the message, the operator asked if he could keep the slip. Why? Livermore asked. The operator replied:

“I’ve been an operator here in Palm Beach for twenty years and that was the first message I’ve ever sent asking a broker to deposit money in a bank account of a customer.

“I’ve seen thousands and thousands of messages passing over the wire from brokers demanding margins from customers. But never before one like yours.”

What Wall Street Giveth, It Taketh Back

Edwin Lefèvre, near the end of Reminiscences of a Stock Operator, said prophetically:

“My study of the history of Wall Street justifies a belief that the same ticker which giveth also taketh away. The only kings that were not ignominiously dethroned were those who abdicated in time and ran away from the danger of destitution.

“And then I thought of other kings for a day. Men who were the leaders of the market after beating the game for millions were eventually beaten by the game in the end.”

Too Negative?

I’m not trying to be negative here - just realistic. If you’ve been taking big profits out of the market, put some of them aside occasionally to build tangible assets, like real estate.

Although cold, mathematical logic dictates that a successful trader should usually keep as much money as possible in the market, history gives another perspective - the perspective of traders who were once successful bankrupting themselves. Who’s to say we won’t suffer this fate? Turning some of our trading profits into tangible assets might not help us become kings of Wall Street - but we might make the grade as princes - and it should stop us sinking to the status of paupers.

Jesse Livermore wrote:

“Analyze in your own mind the effect, marketwise, that a certain piece of news may have… Try to anticipate the psychological effect of this particular item on the market. If you believe it’s likely to have a definite bullish or bearish effect, don’t back your judgement UNTIL THE ACTION OF THE MARKET ITSELF CONFIRMS YOUR OPINION.”

How can we apply Jesse’s thoughts in today’s markets?

When looking for trades, two questions to ask are:

• Is there a good underlying story to engage the interest of other investors or traders?
• Can I see the potential for a big price move?

The two issues are, more often than not, related.

After the market has “given its approval” for a trade, you may buy into the early stages of a trend, hoping that the trend will be solid enough to last for months – or even years. You can also hope the slope of the trend will be rewarding. If the slope is too shallow, you might ride the trend successfully, but make less money than if you’d picked a better trend.

The “story” behind the trade is an important one – because if the story is good enough, it can carry a trend for longer and take it to greater heights than is financially logical. In this context, probably the biggest story in recent years was the dotcom boom of the late 1990s.

The tech industry had a good story to tell and people bought into the story - that the internet was going to take over the world within a few years and bricks and mortar businesses were finished. You can see the impact of this “story” in the first half of graph I’ve pulled from Yahoo Finance comparing the NASDAQ with the S&P 500 at the time.

Performance NASDAQ v S&P 500 November 1998 - June 2001

What about the “Story”?
Buying into the dotcom/NASDAQ story and trend in 1998, or even 1999, and getting out when the trend broke, made a lot more money than buying the S&P 500 - whose “story” was weaker.

Of course, after the NASDAQ uptrend had broken, the big “story” was that the dotcoms were nearly all losing money - and even the ones making money had p/e ratios in the hundreds. The uptrend was over. The story was negative. The dotcoms’ fundamentals were appalling - it was time to sell short and double the profit you’d made on the way up.

Summing Up
When you’re trading, the “story” can be more important than the fundamentals.