Legendary speculator Jesse Livermore is surely one of the most fascinating characters in all of financial-market history.
About a century ago Jesse Livermore blossomed into one of the most celebrated speculators of all time. He was trading heavily in the early decades of the 1900s, a wondrous era to speculate in stocks. His renowned exploits are still viewed with great awe and reverence by today's elite speculators and his towering speculation wisdom will stand tall for ages to come.
If you are interested in more background information on Jesse Livermore and my reasons behind writing this series of essays on the man's awesome speculation wisdom, you may wish to skim the introduction of the first essay in this series.
Livermore's exploits were recorded in the greatest book on speculation of all time. Originally published in 1923, it is called "Reminiscences of a Stock Operator" and was written by a gifted financial journalist named Edwin Lefevre. Lefevre penned the account as if from the first-person perspective of a fictional trader named Larry Livingston. As Lefevre had spent weeks extensively interviewing Jesse Livermore, market historians are virtually unanimous in viewing Lefevre's classic book as a thinly-disguised biography of Livermore's trading life.
Today "Reminiscences of a Stock Operator" is fondly read with awe by speculators of all levels and abilities all around the globe. I have personally read the book many times and I try to re-read it at least once a year now. The speculation wisdom contained within these magical pages is just awesome and truly priceless for all speculators to digest.
If you are interested in speculation and you haven't read the book you owe it to yourself to buy it today at
Jesse Livermore's words and experiences are so endearing and powerful because he presents himself as just another mere mortal like you and I, with hopes, fears, and frailties. He is brutally honest in critiquing his own evolution as a speculator and thoroughly explaining his own mistakes and the great wisdom they ultimately led to.
In this series of essays Jesse Livermore's wisdom is presented chronologically from the book. All the bold-faced passages below are his words directly out of Lefevre's book, while the following normal text is my own feeble thoughts and commentary attempting to pull Livermore's wisdom a century into the future to today. Before every quote below, the chapter in "Reminiscences" from which it is pulled is noted so you can quickly find it and dig deeper by reading the valuable surrounding background context if you wish.
I hope and pray that you find Jesse Livermore's awesome wisdom as exciting and valuable as I have!
(Chapter III) … "If somebody had told me my method would not work I nevertheless would have tried it out to make sure for myself, for when I am wrong only one thing convinces me of it, and that is, to lose money. And I am only right when I make money. That is speculating."
This classic Jesse Livermore quote picks up just where we left off in the second essay, with a further description elaborating on the fascinating game of speculation. Just like our speculating forefathers of a century ago, there remains only a single acid test today for every active speculator to measure his or her success. While the ultimate object of the game is to be right and win, progress is solely measured in terms of capital won or lost. A speculator who is wrong will lose money, and a speculator who is right will make money. Period.
When a new idea for a potential trade arises in your mind, the only way you will absolutely know for sure if you are right or wrong is to bet real capital on your current imperfect perception of an unknown future. If your trade is right, your capital will grow, if your trade is wrong, you will lose money. If an idea for a trade isn't compelling enough to convince you to bet your own actual hard-earned speculative capital on it, then you should immediately walk away without making that particular trade.
As Jesse Livermore colorfully illustrated a couple pages before this quote with a fantastic gunfight analogy, paper trading for imaginary gains and losses is totally useless, a complete waste of time. Only an actual real-world deployment of real capital can validate or refute a trading hypothesis. There is nothing that hones a speculator's instincts like winning and losing his own precious capital trading on his own ideas. Until real money of your own is won or lost, there is no way of knowing the value of any trading idea or strategy.
(Chapter III) … "Everything happened as I had foreseen. I was dead right and - I lost every cent I had! I was wiped out by something that was unusual. If the unusual never happened there would be no difference in people and then there wouldn't be any fun in life. The game would become merely a matter of addition and subtraction. It would make of us a race of bookkeepers with plodding minds. It's the guessing that develops a man's brain power. Just consider what you have to do to guess right."
Shortly before thinking these thoughts, a young 22-year-old Jesse Livermore lost his entire $50k fortune (about $1m in today's inflation-eroded dollars!) on two trades in one morning even though he was absolutely right. He learned a painful speculator's lesson that sometimes strange and unusual things can happen which can torpedo any trade. While it is unlikely that the specific situation that wiped out Livermore this particular time would happen today in the Information Age, the Principle of the Unusual is still extraordinarily important for all speculators to understand.
At the time, Livermore was watching a titanic bidding war unfold for the Northern Pacific Railroad Company between two warring consortiums headed by opposing elite industrialists J.P. Morgan and E.H. Harriman. Livermore watched the stock soar dramatically on the enormous buying demand, but he knew that this extraordinary magnitude of buying pressure was unsustainable and a break was inevitable after such a spectacular run. His trading strategy was to short Northern Pacific immediately and play for the break, and then after the break to quickly cover his shorts and buy long Northern Pacific shares to ride the inevitable rebound bounce play.
Livermore's two-pronged idea was brilliant and should have netted him legendary profits. Unfortunately a lagging ticker tape slaughtered him. A century ago, speculators could only get quotes on physical ticker tape. On particularly active days, the quoted prices on the ticker tape could lag substantially behind the actual trading action in New York. Livermore sold short at $100 per share on the ticker tape and he was right, but to his horror he found out his brokers' executions actually went through at $80. He lamented, "…it seemed to me that I was putting out shorts at a level that made the stocks I sold the very bargains I had planned to buy."
Livermore immediately tried to rectify the poor executions by covering his Northern Pacific shorts. Unfortunately his buy orders at $80 on the ticker tape were actually filled at an average of $95. He lost his entire $50k ($1m today) fortune on both legs of this Northern Pacific trade in a single session on May 9th, even though his trading strategy was perfect and he was "dead right", all because of poor execution. Ouch!
While the technology wonders of the young Information Age make it unlikely that today's speculators could face the same horrific execution peril as Livermore, his Principle of the Unusual is still very important to always consider.
The greatest example I know illustrating this point today was the implosion of the elite hedge-fund Long-Term Capital Management in 1998. LTCM was literally run by the best of the best, brilliant mathematicians and unparalleled market geniuses, but a single unusual extremely low probability event decimated much of their entire massive hyper-leveraged portfolio at once. The LTCM guys would have been right 99 times out of 100, but they were unfortunate enough to suffer through that 1 weird time and it utterly destroyed them. If you want to learn more, read the excellent book on this fascinating episode by Roger Lowenstein, "
This Principle of the Unusual is often on my mind today, since our speculation approach at Zeal is also based off of trading historical market probabilities, just like Livermore or LTCM. Because the unusual is always possible, I strongly encourage all speculators to maintain a diversified portfolio of speculations, like I outlined in "Bear-Market Portfolio Design".
Even the phenomenally wise ancient Israeli King Solomon articulated this timeless wisdom in his book of Ecclesiastes three millennia ago saying, "Cast your bread upon the waters, for you will find it after many days. Give a portion to seven, or even to eight, for you know not what disaster may happen on earth."
As a speculator, you have to constantly make sure that your bets are spread out, to seven or eight different places as Solomon recommended, and that you never, ever bet your entire fortune on one particular play, like Jesse Livermore did, regardless of how good it may look at the time. Also strictly limit your overall risk by fanatically deploying and heeding stop-losses on your stock plays as well as only deploying small percentages of your entire portfolio in any single options or futures play. Prepare for the Unusual!
Jesse Livermore's ugly experience in his Northern Pacific play offers priceless wisdom to today's speculators. As speculators, we all have to be aware of the ever-present possibility of something really unusual transpiring out of the blue. To minimize the damages we will suffer under such an event, we must diligently limit our risk accordingly by spreading our speculative capital across different speculations and ensuring that we never bet too high a percentage of our fortunes on any one particular speculative bet.
(Chapter III) … "I can't tell you how it came to take me so many years to learn that instead of placing piking bets on what the next few quotations were going to be, my game was to anticipate what was going to happen in a big way."
Once again for the umpteenth time Jesse Livermore points out that ultra-short-term trading isn't where the Really Big Wins lie, but in correctly anticipating major bull and bear moves in the financial markets. There are more classic Livermore quotes along these lines in the first and second essays I wrote on "Reminiscences", but this point certainly bears repeating in our instant-gratification hyperactive Information Age trading society of today.
It is certainly psychologically challenging ignoring the endless day-to-day market noise to focus on the big picture, but legendary gains are most often found in riding these macro moves. At Zeal we continue to strive to do just that in our own index-options trading, as I discussed in our "Trading the NASDAQ Bust 2" strategy essay in January and as I continue to discuss each month for our
As speculators, our highest probability of winning big while at the same time minimizing our risks as much as possible lies in stalking, deploying in, and riding out the major market moves.
(Chapter III) … "If I hadn't made money some of the time I might have acquired market wisdom quicker."
I just love this candid observation of Jesse Livermore's! It is so painfully true, and kind of funny too!
All speculators, especially relatively new ones, can benefit tremendously by digesting the vast wisdom contained inside this small sentence. In speculation, just like in life, important lessons are learned best when they cause some pain and discomfort. For speculators, nothing is quite as painful as being wrong in a trade, which means they are losing money. These trades that end up as losses are extraordinarily important because they grant us an immense opportunity to study them and learn some valuable new lessons about how the markets really work that will help us execute far superior trades in the future.
Just as it is potentially dangerous for a new Vegas gambler to win big at his first time at the casino tables, as Livermore points out early speculation wins can lead to overconfidence and crowd out opportunities to learn. While wins are much more fun at the time than losses, paradoxically it is often a speculator's losses that lead to priceless lessons learned and trading wisdom acquired that lay the foundations for future success.
Jesse Livermore himself points out here that he probably would have learned how the markets worked much faster if he hadn't won "some of the time" in his early days as a professional speculator. Celebrate your wins, but make sure you study and learn from your losses too!
(Chapter IV) … "I was twenty when I made my first ten thousand, and I lost that. But I knew how and why - because I traded out of season all the time; because when I couldn't play according to my system, which was based on study and experience, I went in and gambled. I hoped to win, instead of knowing that I ought to win on form."
While surprising to non-speculators, there truly is a fine line between intelligent speculation and Vegas-style gambling. Intelligent speculation, as Jesse Livermore wisely points out, is "based on study and experience" that inevitably leads a speculator to periodically recognize special situations in the markets where they know that they "ought to win on form". Intelligent speculators only make big bets at these very times when everything seems to line up perfectly behind their knowledge and experience to tell them that a trade has a very high probability of emerging extremely profitably.
Livermore said many times that his greatest successful trades were products of his study and experience, when the markets presented him with spectacular opportunities that he knew would prove profitable to trade. But, like all speculators, Livermore also succumbed at times to the powerful temptation to gamble, when he "traded out of season" because he was too impatient to wait for an ideal time when he could again play according to his system. During these gambling episodes, he lost an enormous amount of money as he didn't trade based on solid knowledge and experience, but on mere whims.
During these gambling episodes Livermore "hoped to win", like all speculators, but he wasn't convinced and convicted enough based on his experience to know he "ought to win". Intelligent speculators know there are times to trade and times not to trade. This also reminds me of King Solomon's fantastic wisdom of Ecclesiastes, also absolutely required reading for speculators, where the ancient Israeli sage proclaimed, "To every thing there is a season, and a time to every purpose under the heaven: ... A time to get, and a time to lose; a time to keep, and a time to cast away;". In speculation terms, this means a time to trade, and a time not to trade!
When you inevitably find yourself unsure about a speculation, if you feel that you can't currently trade your "system", which is your hard-won body of knowledge and experience on the markets, then it is best not to trade at all. Trading "out of season" is merely Vegas-style gambling and odds are you will lose. Don't feel compelled to trade all the time, as all you need to do is catch part of the big moves to build a fortune. Leave the stressful and counterproductive ultra-short-term out-of-season gambling to someone else.
(Chapter IV) … "There is nothing like losing all you have in the world for teaching you what not to do. And when you know what not to do in order not to lose money, you begin to learn what to do in order to win. Did you get that? You begin to learn!"
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Even though he is still celebrated as one of the greatest stock operators in history, Livermore himself went completely broke several times as he was learning the game, and even later near the end of his life. He had won and lost vast amounts of capital before he even reached his mid-20s, and he knew exactly what it was like to fall from the top of the world down to nothing when his speculative capital was completely vaporized.
In my early days of options trading, I too once lost virtually all my speculative capital on a single trade. I was distraught too, as I had worked darned hard to save that capital. I lived like a monk at the time, renting a small apartment and driving an old car so I could save the capital necessary to speculate. I made the lethal mistake of gambling rather than intelligent speculating though and I compounded that error by throwing the vast majority of my capital behind a single trade, which was foolish. I went from being blessed with having plenty of speculative capital to having virtually none at the time.
But, losing it all in one's early years of speculating is par for the course. Jesse Livermore wisely points out above that there is no better way to learn how to make money than by losing "all you have in the world for teaching you what not to do." Most of the wealthy self-made private speculators I know today went through this same painful learning process, losing most of their initial capital early on which taught them the hard and painful lessons that helped bless them with much success later.
A German speculator friend of mine tells me that speculating is like riding a motorcycle, as he claims that one is not a real biker until they dump their bike and crash at over 30mph. Only after that first motorcycle crash is one formally a biker, per this gentleman! Similarly, for some reason losing it all in the early years is part of the necessary education of most successful speculators. It is a powerful lesson as Livermore wisely points out!
If you find yourself in this unfortunate position of losing it all while learning to speculate, please realize that you are not alone and that countless others have been through this exact same predicament before you. Pick yourself up, dust yourself off, learn your hard lessons, and start working hard in your real job to save up speculative capital once again. Once you scrape up another modest capital bankroll, get back in the saddle! Now that you have learned "what not to do in order not to lose money, you" can "begin to learn what to do in order to win." Never give up!
Well, unfortunately this is all of Jesse Livermore's wisdom that fits into this third essay of my series on "Reminiscences". I hope you found Livermore's great wisdom enlightening!
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Until next time, Godspeed and happy speculating!