Introduction

About the book:

The book is written by one of the greatest traders of all time, Jesse Livermore. At the peak of his career, Livermore’s net worth was $100mn in 1929, which adjusted to today’s dollar is equivalent to $1.5bn. This book was written shortly before his death, this book accounts the trader’s fascinating autobiographical and historical details of trades during his lifetime, a must read for speculators looking to make money trading across asset classes.

The book includes some of the highlights of a lifetime of speculative experience—a record of some of the failures and successes and the lessons that each has taught him. Out of it all emerges his theory of “time element” in trading, which he regards as the most important factor in successful speculation. 

The book starts with the description of Livermore’s new year ritual, which is to visit his bank vault and stay there for two days and three nights. During his stay here, he would take a feel of all the money he earned during the year ($50mn as mentioned in the book) and also read through his trading notes to understand what went right and more importantly, wrong, during the year. He is said to go for a vacation during the start of the year and spend a lot of money on leisure activities. 

About the author:

Jesse Lauriston Livermore was an American stock trader. He is regarded as a day trading pioneer. He left his job at the young age of 16 and started trading full-time. He borrowed $1000 from his mother & within just three years, he accumulated $10,000 in profits. A 1000% return is exceptionally outstanding; that shows how good he was in day trading. 

Buy the book:

The book is written for those who are willing to work and study to attain sensible results in day trading. 

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Challenge of Speculation

The game of speculation is not for the mentally lazy or for emotionally weak personality or for the get-rich-quick mentality. The author strictly advises them to stay away from trading as this profession would make them die poor.

The game of speculation should be treated as a business rather than mere gamble. Livermore advises us to keep a record of trades and study that periodically in order to determine the success and failure rates.

Stock investing and stock speculation can be profitable at times, but trading cannot be a reliable source of income every day or every week of the year.

“UNTIL THE ACTION OF THE MARKET ITSELF CONFIRMS YOUR OPINION.”

• The author states that one should take a trade only when the stock has started moving in your direction. 
• This means that if you have a stock that is currently trading in a range of $20-25 and you expect it to reach $50. You should not jump to buy the stock as and when it crosses $25. Wait for it to confirm the direction and let it move a bit, say to $28 and then place a buy order. 
• Also, as long as the stock is moving as per your expectations, do not haste in squaring off the trade, i.e. do not be in a hurry to take a profit.  

“Profits can take care of themselves, not losses”

By this statement, the author brings home a very important concept of speculation to cut the losses short and let the profits ride.
Livermore is not a big fan of charts, rather he keeps records of his trades. We will see in the following chapters as to what these records are and what actually is the ‘Time Element’, the author has been stressing on so much.

When Does a Stock Act Right?

Similar to individual personalities, stocks possess characteristics too which determine their movements. Researching about these characteristics allow traders to predict a trend and also get out of the trade when it starts moving adversely.

For an illustration of the author’s research on the movement of stock in a trend, let’s consider a stock that is currently trading at $50. 

• On the first leg of the uptrend, it moves to 54. This is usually a gradual movement. After say 2 days, it retraces back, slightly to 52. 
• Now, the upward movement will be with more force and this time it will reach 59 or 60 in just 3 days (in a short span of time). This trend has a reaction again, but this time, instead of a two-point reaction, it might be a stronger one. 
• Now, again when it resumes the uptrend, you’ll notice the volumes will be lower than what it was at the beginning of the up move from 50 to 54.
• However, because of lower volumes, the movement will be even higher this time and can move from the previous high of 60 to 70 without any retracement.

Now, Livermore gets to the concept of the “Time Element”. You must exercise patience after making a good profit, but don't let patience lead you to lose sight of the warning signs.

The stock begins to rise once more, rising six or seven points in a single day, then eight to ten points the following day — with a lot of activity — before suddenly breaking abnormally by seven or eight points in the final hour of trading. The following morning, it increases its reaction by one or two points before starting to move forward once more and closing quite forcefully. For some reason, though, that didn't happen the next day. This is a warning of impending danger.

Here traders are advised to take a side track and move out of the trade. They even should not get into the stock again, till normalcy its movements are witnessed once again.

Follow the Traders

An extremely curious person who tries to find reasons behind every movement behind stocks often clouds his/her mind with non-essential information, thereby either taking wrong decisions.

Livermore reveals that he was one of them too. In this chapter, he lists out two of the common mistakes that many other novice trades make:

1. Interest in too many stocks

One should remain focused on just a few stocks which he or she can understand and should not trade a large number of stocks. It is much easier to track a few than many.

2. Be completely bullish or bearish on the entire market based on movement of one stock.

This is a commonly noticed issue with retail traders. In the context of India, people view heavyweights such as Reliance Industries as the market and hence if Reliance shows a downtrend, they extrapolate it as a downtrend in Nifty. This is rarely the scenario.

Livermore advises to rather look at a group of stocks preferably from different sectors and then make a perception about the market.

The author now shifts his focus to tell us about the study of movements. Remember record keeping? Here, he states that one should confine his studies of the market to just the leaders/ prominent stocks. Also, it is important to note that leaders keep on changing with time. This was seen in the Indian context as well when SBI and other PSU used to be the market leaders in the 1990s whereas now it’s the private sector leading the wagon.

Therefore, always try to trade in leaders or high market cap stocks, which not only are the most active but also provide you with ample liquidity in case of a trend reversal.

Money in Hand

Faulty speculation is one of the main reasons for losing money in the stock market. The majority make the mistake of averaging down losses which ultimately leads to revenge trading and hence more losses. Therefore, Livermore has advised to strictly avoid averaging down. Commit more money to a trade only when it is moving in your direction. On the other hand, try cutting down losses when the trade moves in the adverse direction.

The other common mistake that the author speaks about is the faulty urge in individuals to make unrealistic returns in a very short period of time. He quotes that a 500% return in 2-3 years is reasonable expectation in trading, however, expecting a similar return in 2-3 months is fatal.

The author believes that speculation should be considered as a business and hence have similar return expectations from trading as a businessman would expect, say, from opening a shop or a store. 

Every time a successful deal is closed, a trader should make it a routine to collect half of his winnings and place them in a safe deposit box. Speculators only ever withdraw money from Wall Street after a successful deal is closed, and this is the only money they ever take out of the market.

Livermore followed a similar strategy. 

Hence his advice in this chapter is that money in a broker's account is not similar to what it is in hand.

The next advice that Livermore gives in this chapter is to avoid overtrading. Now, if the speculators were smart enough to know at which time they should over-trade, the practice would be justified. There are times when they could or should over-trade. But once acquiring the habit, very few speculators are smart enough to stop. They are carried away, and they lose that peculiar sense of balance so essential to success. Never listen to brokers as the incentives are not aligned in this business. The broker earns when the trader makes frequent trades. Hence his advice would always make you trade more frequently when you are trading on your own analysis. The author reminded that Proper analysis should include “Record keeping” and “timing the trade” at important pivot points.

The Pivotal Points

The last chapter introduced something called “important levels” for timing the trade. Those important levels in the author’s language are termed “Pivotal Points”.

These pivotal points are discovered via record keeping of the movement of stock prices in a notebook. When you note down the movements of stock, you recognize that there are certain levels, like a psychological price point (round numbers - $100, $200, etc.) or relative points such as 52 weeks high or low, which when breached define the trend of the stock.

Livermore started the position only when the stock reached the pivotal point and thereby would slowly increase his position as it moved in his desired direction. Additionally, he notes that just as the market gives you a tip of when to get in the trade (via pivotal points), similarly, it gives you an indication of when to exit the trade.

For example: Consider a stock that has been declining for a while and reaches a low point of 40. It then makes a rapid run up to 45 in a few days, backs down for a week in a few point range, and then continues to extend its run up to 49. For a few days, the market becomes boring and inactive. The stock should sell below its pivotal point of 40 by three points or more before it has another significant bounce if it truly intends to resume its downward trend. This is the time to pay close attention to the market. If it fails to break through 40, it is a sign to purchase when it recovers 3 points from the low price reached during that reaction. When it reaches 43, if the 40 points have been penetrated but not to the necessary extent of 3 points, it should be purchased.

For exits, Livermore quotes, “Bear in mind when using Pivotal Points in anticipating market movements, that if the stock does not perform as it should, after crossing the Pivotal Point, this is a danger signal that must be heeded.”

Livermore summarizes his trading strategy as “Timing, Money Management and Emotional control”.

Million Dollar Blunder

In this chapter, Livermore stresses on the importance of position sizing. Once the stock breaches the pivotal point, most traders make the mistake of putting in the entire stipulated amount in one go. The trick however, is to allocate it as the stock moves in your direction.

Say, a stock is trading at 100. You want to buy a total of 500 shares of the company. So, you should buy 300 qty at 100 and allocate 100 qty at 105 and the remaining 100 qty at 110. This way you can also see if your judgement about the stock’s trend is correct or not. This was the same method used by Rakesh Jhunjhunwala in his trading and he used to call this “Pyramiding”.

Study your book of price records and the price movements of the past few weeks—looking for the Pivotal Point. When your chosen stock reaches the point you had previously decided it should reach if the move is going to start initially, that is the time to make your first commitment. Having made that commitment, definitely  decide  the amount of money you are willing to risk in case your calculations go wrong. You may make one or two commitments on this theory and lose. But by being consistent and never failing to re-enter the market again whenever your Pivotal Point is reached, you cannot help but be in when the real move does occur.

The author also asks the readers to stay away from insider information or tips in the stock markets. The author illustrates a story wherein a friend of Livermore got a tip to buy a stock. He bought it in no time. Everything went rosy for some time as the company was giving positive results and the stock price went roaring. However, one fine day, it started to reverse sharply. This was the time when Livermore’s friend called up the tip giver for more information. In spite of knowing the exact situation in the company, he misinformed the trader and told him to hold the stock. This Livermore explains was because the tipsters were busy selling their own stocks in the market. 

This is how the operating market works all over the world, including India. Hence always trade by reading charts or record keeping (which is nothing but a textual representation of charts) as Livermore suggests.

Three Million Dollar Profit

In the last few chapters, the author described how he struggled to reach perfection or his failures. In this chapter he discloses what his best trades were. He made a humongous bet on Wheat and Rye in 1924, which led him to a huge profit.

First, he identified a pivotal point (resistance point). Wheat crossed the point he bought a few lots of Wheat, however, the price action remained dull for a few days. Livermore waited for Wheat to cross the next pivotal point and thereby began placing his next lot of buy orders. An important lesson for the readers here is to size up the trade only when you see that the stock is moving in your direction, i.e. when it crosses the first resistance, do not jump in with the entire amount, divide it amongst various resistance zones and buy it as soon as it gives a break out.

After the first extraordinary move, Livermore decided to exit the trade. However, when wheat went up again (significantly), he realized that he had made a mistake. This made him realize that one should not get attached to the profits. It's not prudent to exit a trade prematurely. 

The other large trade was in Rye. This time Livermore was short on Rye and hence once it breached the pivotal point (support in this case), he placed a sell order. Similar to his practice of position sizing he kept on placing sell orders as the trade moved in his favor. 

The author also emphasized on the importance of trade execution by the broker. In the current era of mobile trading, we place orders ourselves and brokers have little control over our trades.

However, in the past, brokers had a lot of control over placing the orders. Livermore remembers that his broker had executed his Rye trade very effectively. His broker halted his order for some time, as he saw a large lot was going to be sold in Rye. Hence, once the large sell off happened, the prices went down further and Livermore could cover up his shorts at a better price, thereby making him an extra profit of $350,000.

How to Trade Stocks: Timing

The next three lessons summarize the previous chapters. Although in this version of the book, some extra points are delivered and hence are important to read as well.

The three important aspects of being a successful trader are: 

• Timing 
• Money Management
• Emotional Control

In this chapter let’s elaborate on the first aspect i.e, Timing.

Livermore has always emphasized that “time is everything”. This is validated by his concept of waiting for the pivotal point from entry and being watchful of unusual movements in the stocks which contradict its normal movements. Hence, he had advised us to trade in only a few scripts that would enable us to have in-depth knowledge of its movements.

Before making any trade follow the process of Top Down Trading:

1. Check the market: Before entering any trade, the first step is to be sure where the overall market (Nifty50) is heading. If your trade confirms with the direction of the Nifty, it has a higher chance of succeeding. For instance, Moving averages can be a useful tool for determining the trend of the index.
2. Check the trend of industry groups. When you trade in a stock, it's not only following the general market (Nifty) but also the industry in which it is categorized. For e.g., If you want to trade in Maruti Suzuki Ltd, check the trend of the Nifty Auto index as well. This will provide more assurance if your trade is in sync with the trend of the industry group (Nifty Auto)
3. Check the tandem of peer stocks. You should also check whether the “Top” peer group is also moving in a similar trend or not.
4. Check all  four: The market, the industry group, the tandem of peer stocks and the stock itself, your chances of hitting the correct trend becomes more probable.
5. Do a final thorough analysis of the individual stock you have decided to trade. This is your responsibility, your obligatory “Due Diligence.”

“Wait until the Preponderance of Evidence is in your Favor. Use Top-Down Trading. Be patient!” —Jesse Livermore.

Industry tracking is very important as per Livermore. It happens that sometimes, a particular stock performs exceptionally better than the entire sector, however, be ready as the other stocks can follow suit very soon.

Another very interesting theory of Livermore was “Follow the leaders”. Here he meant the trending stocks. On a particular day, list out the most trending stocks and try to see where you can trade (of course, by looking at the pivotal points!). Secondly, keep the trading universe small and controllable. 

An interesting quote on his trading style, which differentiates him from others: “Just because a stock has fallen in price does not mean that it won’t go lower. I never buy a stock on declines, and I never short a stock on rallies.” He never anticipated,Lets now shift focus to Tandem Trading discussed above. Tandem trading can also be called Sister Stock Trading Method. Livermore advised never to trade only one stock from a sector, look at two. Why? Because, stocks in the same group move together. If one has already moved, chances are that the other twin will move very soon.

Livermore always considered “TIME” as a real and essential trading element. He would often say: “It’s not the thinkin’ that makes the money—it’s the sittin’ and waitin’ that makes the money.” There were many occasions where Livermore kept cash until the right situation appeared. “Often, the market will go contrary to what a speculator has predicted. At these times the successful speculator must abandon his predictions, and follow the action of the market. A prudent speculator never argues with the tape, remember: MARKETS ARE NEVER WRONG—OPINIONS OFTEN ARE.

When to buy a stock is based on the trend as recognized by pivotal points. One of the most used pivotal points by Livermore was a new high. Whenever the stock crosses a new high, according to Livermore, there will be no overhang for traders to exit the position. On the contrary, with a falling stock, each rise is accompanied by a sale from the traders who want to exit even at breakeven. Hence, breakout to new highs is considered a good buying opportunity.

Do you remember Livermore stating Danger Signals as an exit point?

One of the Danger Signals that Livermore used was ‘One Day Reversal’. This happens when the current day's high is higher than the previous day's high, the current day's close is lower than the previous day's close, and the current day's volume is higher than the previous day's volume. When something similar happens, stop the trade. Additionally, if there is significant volume but prices stagnate, do not rise, do not reach new highs, and there is not a strong continuation of the current advance, this is frequently a big hint, a warning that the stock may have peaked out.

In the next chapter, we will discuss the importance of money management.

How to Trade in Stocks: Money Management

As discussed earlier by the author, the three important aspects of being a successful trader are: Timing, Money Management and Emotional Control. Let's discuss Money Management in this chapter.

Money Management: Livermore used to call cash – the lifeline of traders. A speculator without cash is like a store owner without inventory. His rule of not putting all the stakes at one price is an attribute of money management principle. 

Firstly, decide the total quantity you want to purchase in an upward trending trade. Secondly, in an upward trending market, each additional purchase should be at a higher price. Thirdly, it is prudent to purchase a higher number at each additional purchase as an indication of higher conviction of the trend.

The trader should also establish a general upside target. Livermore believed in never exceeding losses of more than 10% of the invested capital. The 10% stop loss rule will help you NOT become an involuntary investor. This is a type of investor who went in as a trader but because of the losses, he refused to sell the trading stock and hence became an investor. Another stop loss is when the broker calls for additional margin money.

The other rule is to keep cash reserves. There are never ending streams of opportunities in the market. Hence you should also have some reserve cash in order to benefit from the same. Relevant quote on this by Livermore: “THERE ARE TIMES WHEN PLAYING THE STOCK MARKET THAT YOUR MONEY SHOULD BE INACTIVE—WAITING ON THE SIDELINES IN CASH—WAITING TO COME INTO PLAY—IN THE STOCK MARKET—TIME IS NOT MONEY—TIME IS TIME—AND MONEY IS MONEY.”

An interesting way to do the above money management task of “keeping reserve” is to take out 50% of your profits and keep it in bank FD.

Stick with the winners as long as the stock is acting right. This is basically to signify, not to exit prematurely. In the stock market, the money is never yours. It’s stock market money. Conversely, it is equally important to cut the trade when acting against you. This principle is known as Antifragility. Livermore very aptly said, “Profit takes care of themselves, Losses never do.”

We will discuss more on emotional control in the next chapter.

How to Trade Stocks – Emotional Control

A little-known fact is that Livermore used to take psychological lessons at night school to better understand human nature. From there, Livermore deduced that although there may be millions of brains at work in the market, only a small number of psychological patterns needed to be researched and understood because human nature shares certain characteristics.

By personality, Livermore was a disciplined man. He went to bed early every night, by 10 PM and rose at 6 AM. In stock markets, according to him, to be successful, one needs silence, seclusion and time to dive deep into new information that comes every day. A careful, disciplined man needs to be aware of everything and ignorant of nothing. You can not afford to be careless in the field of trading. Apart from being mentally fit, a good trader also needs to be physically fit.

The rules of investment and trading are different. In comparison, you might have heard many successful investors categorizing themselves as contrarian; it's rarely fruitful in the field of speculation. Livermore was a trend follower and hence moved along the crowd, most of the time. The only time he went against the crowd was when the change in trend was to be spotted. He believes that change in trend is the most difficult time in a speculator’s trading life.

He has two rules for keeping his emotions under control in trading:

1. Never be invested in the market all the time. Be in cash when unsure of the market direction.
2. Use pyramiding as a tool to allocate capital to a trade. This means you start with a small allocation and size up the trade as the stock moves in your direction.

He advises us to remain far from people who give tips and even the management of the company that provides guidance to influence stock prices. According to him, the most money he has lost was when someone gave him tips on what to buy or short. He later went on to decide that whenever he loses money, it should be because of his own mistake. 

The three important characteristics of practicing emotional discipline are:

• Poise (Balanced person with dignity of manner)
• Patience
• Silence (Keep your victories and failures to yourself)

The astute stock market trader manages his emotions and always makes decisions with the future in mind rather than the present or the past. In light of this, it appears as though a crystal ball may always be used to predict these emerging Industry Groups that will eventually become the new strong sector-stocks for the current rally.

Conclusion

The book can provide a good start to traders. Livermore, who himself is a self learner, has made money out trading and has provided his own failures and successes so as to train amatures like us. The major factor to get success in speculation in any instrument is Timing, Money Management and Emotional Balance. The correct measurement of these three along with proper record keeping and understanding of charts/ prices, can be instrumental in a trader’s journey. Another book on the life of Jesse Livermore, “The Reminiscence of Stock Operator” is a good read as well.