Last Friday, November 28th, was the 74th anniversary of the death of legendary Wall Street speculator Jesse Livermore. Once dubbed "the most fabulous living US stock trader" by Time magazine, he declared bankruptcy in 1934 and took his own life six years later.
Today's environment is very different to the one in which Livermore made and lost several fortunes, but he remains an iconic figure. Traders and investors alike continue to eulogise Reminiscences of a Stock Operator, a fictionalised biography of Livermore which is as illuminating as it was when first published in 1923.
It is also an enthralling read. Livermore first developed a taste for market speculation as a teenager and was so successful that he was eventually banned from bucket shops, the infamous gambling houses of the day.
In 1898, aged 21, he moved to New York to trade via conventional stockbrokers and became an adept tape reader, studying price action to gauge supply and demand. He made his first million during the 1907 market crash, his bearish bets leading JP Morgan to ask him to stop short-selling in order to avert financial chaos.
Livermore’s fortune was short-lived, most of his profits soon wiped out following a bad cotton trade. By 1914, he was bankrupt, but he profited handsomely in the following years. His greatest triumph came in 1929, emerging from the Wall Street crash with some $100 million in profits. Adjusted for inflation, that would be worth about $1.4 billion today.
Livermore's 1929 adventures cannot be found in Reminiscences – it was published six years earlier – but it nevertheless captures the excitement of the trading game.
Even today, 91 years after it was first published, it is a "textbook for speculation", as renowned hedge fund trader Paul Tudor Jones puts it. In the foreword to the latest edition, Jones relates how he was first given the book in 1976 by his then boss, who said it was "the most important book I could read". Since then, Jones has read the book "countless times", and "cannot remember a single time when I haven't discovered something new".
, who interviewed over 30 renowned traders for his book,
, used to routinely ask his subjects what books they would recommend to aspiring traders.
was “by far” the most recommended book.
The fact the book remains so influential today is a lesson in itself, says money manager and Reformed Broker blogger Josh Brown. "That lesson is that there are rules to this game," he says, "certain disciplines that have always been true and should not be violated."
Livermore’s trading rules “are as practicable and essential now as they were in the early 20th century”, he adds. “His discussions about tipsters, respecting trends, recognising market characteristics and position sizing are still the gospel. Every serious trader can recite whole passages of the book on demand.”
For the most part, Livermore was a trend trader, which meant buying the leading stocks in bull markets and selling the weakest stocks in bear markets. Averaging down into losing positions was deemed a cardinal sin; instead, losses should be taken quickly, while traders should only add to profitable positions.
The book’s appeal is not confined to the trading community, however, routinely cropping up in the recommended reading lists of long-term investors who care little for Livermore’s high-octane approach.
, co-founder of Merrion Capital and now running GillenMarkets.com, describes the book as a “compulsive read”, and one that will help investors gain a “good understanding of certain stock market operations”.
Indeed, it's striking that much of what Livermore preached has since been validated by behavioural finance experts and academics. For example, studies have shown that investors tend to hurt their portfolios by prematurely selling their winners and holding on to losing stocks. The cause of such behaviour is an instinctive loss-aversion, as illustrated by Daniel Kahneman, whose research won him the Nobel Prize for Economics in 2002.
As far back as 1923, Livermore said it was “absolutely wrong to gamble in stocks the way the average man does”, whereby he takes quick profits but lets his losses ride. These “deep-seated instincts”, these “natural impulses”, must be resisted. “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.”
Similarly, Livermore’s momentum approach – “Prices are never too high to begin buying or too low to begin selling” – may seem crude, but academic evidence shows momentum to be even more important than valuation in financial markets. Recent winners continue to outperform for some time, just as losing stocks continue to lag.
Since 1927, the spread of recent winners over recent losers averaged 8.3 percentage points annually, almost twice as great as the gap between cheap and expensive stocks. Studies indicate the momentum effect to have persisted for over two centuries in US and British stock markets.
Livermore’s adventures are frequently extolled by the get-rich-quick chancers who populate the internet, but he had little time for such people. The “game of speculation”, he said, “is not a game for the stupid, the mentally lazy, the person of inferior emotional balance, or the get-rich-quick adventurer. They will die poor.”
Acting on apparently inside tips, he added, “will break a man more quickly than famine, pestilence, crop failures, political readjustments or what might be called normal accidents”. Nor did he preach a hyperactive trading approach.
He evolved from his early tape-reading days, realising it was better to “buy right, sit tight”. Money “is made by sitting, not trading”, he said. Trying to “jump in and out” is “fatal . . . Nobody can catch all the fluctuations. In a bull market, your game is to buy and hold until you believe that the bull market is near its end.”
The “Wall Street fool” thinks he must trade all the time but “no man can always have adequate reasons for buying and selling stocks daily – or sufficient knowledge to make his play an intelligent play”.
As Josh Brown has noted, Livermore “was a trader but he knew the value of staying with positions and sometimes not trading at all”.
For all his market wisdom, however, Livermore’s tale is ultimately a cautionary one. He often broke his own trading rules, as shown by his numerous bankruptcies. Recognising his own weaknesses, he invested $800,000 in annuities for his wife and children in 1917, an investment he was prohibited from accessing. “I knew a trading man will spend anything he can lay his hands on”, he said. “By doing what I did, my wife and child are safe from me.”
As Josh Brown has noted, Livermore, who had long battled with depression, “excelled at a skill that ultimately made him rich but kept him constantly on edge”.
There was to be no recovery from his 1934 bankruptcy. Although that aforementioned financial trust ensured his family was financially secure, his identity was inextricably linked to his trading, and he committed suicide in 1940, believing his life to be a “failure”.
Livermore understood the demons and frailties that bedevilled traders and investors; tragically, he could not overcome his own. “A loss never troubles me after I take it,” he once said. “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.”