A while back @Chrissayce sent round on Twitter a list of Jesse Livermore’s Trading Rules - these are clearly intended for Stockmarket Players with a ‘Trader’ mindset rather than that of an ‘Investor’, but I wondered how they related to how I go about things. In addition, are there insights here that I can learn from and possibly incorporate more in how I do stuff?
Jesse Livermore was a legendary Wall Street Trader from the early 20th Century I believe, and his story was captured in ‘Reminiscences of a Stock Operator’ by Edwin Lefevre. He was quite a colourful character by the sound of things and went Bankrupt several times and was divorced about 5 times and ended up committing suicide. You can find a free PDF of the book here:
Something that fascinates me about this guy was that he of course ‘Traded’ using the ‘Ticker tape’ that came from a Telegraph Machine in a Stockbroker’s Office. As I understand it, these machines constantly pumped out updated Stock Prices in a never-ending stream during the Trading day - I find it incredible that this was the information he had to go on to make his Trading Decisions - there were no Real Time Charts or Level2 in those Days !! It wasn’t even possible to get up to date P/E Ratios or Divvy Yields or anything - to an extent many Traders must have been in the same boat but it is easy to see how people nearer to the action on the Floor of the Stock Exchange would have a huge Informational advantage (that must have been the equivalent of putting High Frequency Trading computers next to the Exchange these days !!).
Chris clearly adheres to these principles to a large extent and even says he sings these in his car !! The following link gives more detail:
I will go through each Rule in turn and explore how they relate to my methods.
1. Nothing new ever occurs in the business of speculating or investing in securities and commodities.
I guess this Rule just states something that I would say is pretty much true - after around 17 years of dabbling in the Markets it is fair to say I have seen many repetitions of the same things over and over. I guess this is rather helpful because it means that once you have experience under your belt, you are well placed to take advantage of Trends and the Rhymes of History. It is a well known adage that when someone claims “This time it’s different !!” - they are wrong, it never is different. This occurred in the Dotcom Boom when young Analysts etc. were claiming that traditional Valuation Models were no longer valid - “this time it’s different” - it wasn’t, and lots of money got lost by people (like me, sadly) who got suckered into the hype. I guess if you just bear in mind these last few sentences, then it will be a valuable concept to remember for the future.
I guess the only thing to add here is that even if the Markets and Economics side of things never changes, it doesn’t mean that you cannot learn new things constantly and I think that is a big appeal of the Markets to me that it is a never-ending education.
2. Money cannot consistently be made trading every day or every week during the year.
I can’t argue with this - in my experience you have to be able to sway with the ebb and flow of the Markets and to take these movements in your stride and to remain dispassionate, relaxed, analytical and logical irrespective of the Market’s best attempts to influence your emotions and force you into stupid errors. My approach of tending to make Trading Decisions outside of Market Hours helps to avoid the dangers caused by the Market’s impact on our emotions.
This is also related to overall expectations for Returns over a year - I want to achieve 10% Compounded Annually over many many years - I think this is a realistic and sensible goal. If you try to achieve silly numbers like 50% a Year then you will fail badly and it will be extremely stressful - this kind of thinking goes hand in hand with an inability to accept the swings of the Markets and the swings in the Valuation of your Share Accounts. Trying to win all the time is just going to screw you up emotionally because it is not possible - most Short Term Traders have Win Rates as low as 40% or so - and I expect probably 20% of my Stocks to do badly even with the benefit of very long holding periods and careful Averaging Down.
You simply have to accept that there will be many bad days and in fact you will get long losing periods - god only knows we are going through a tough period at the moment and I have been losing money since the start of 2016. It is something I accept because I know there is a lot of 2016 left and if I stick to how I do things I am pretty sure I can improve on the current position. Panicking and changing my Approach at this point in time, just because of a few bad weeks, would be very silly I suspect.
3. Don’t trust your own opinion and back your judgment until the action of the market itself confirms your opinion.
I like this Rule a lot and it most definitely applies to my Approach. I like to select my Stocks to Buy based on their Fundamental attractions but then I want the Charts to tell me when to Buy. If the Stock is in a Downtrend then the Market is sending me a message that something might not be good about this Stock and even if the Stock is great Fundamentally, that is irrelevant because the Market is just not interested in buying it. You cannot make money even if you have ‘the Best Company in the World’ if other Market Participants are not prepared to Buy it with ever higher prices - so there is no point fighting a Downtrend. In addition, once I have a Buy Signal and I take an Initial Stake, I then want the Market to give me another Buy Signal so that I can topup - I guess this way I am getting 2 confirmations that the Market agrees with my Decision to buy into this Stock.
I always want to be in a position where I have a view about a Stock (or the Market as a whole) from a Fundamental viewpoint and the Technical Picture to back that up. For example, Banks have been falling a lot lately and are in a horrible Downtrend - I could not understand why this was happening (my Mental Picture of the Fundamentals was in conflict with what the Market was telling me) so I started digging around to get a grip of what Negative Interest Rates really means and why this presents a huge problem for the Profitability of Banks.
4. Markets are never wrong-opinions often are.
This one is a little more problematic for me - I sort of get the gist of it but I agree a bit and I disagree a lot. The Contrarian in me (which in reality perhaps doesn’t come out to Trade all that often) believes to a large extent that over longer timeframes (I guess over 6 months or something), the Market very often gets things wrong - this is borne out by several Takeovers that I got on my Stocks last year, which clearly show that the Market was wrong. I really do not believe in this ‘Efficient Market Hypothesis’ stuff - I think it is utter nonsense.
On the other hand, there is a certain truth to Jesse’s Rule here - Markets are what they are, there is no point in fighting them really. If you do have to fight them, then make sure you have Low Exposure at Risk and you have a Plan to get yourself out of a Losing Position - that may be to buy more and Average Down or whatever. If I still like a Company Fundamentally, then I am pretty relaxed about fighting a Downtrend as long as I can see a way out in the not too distant future. As another Legend, Ben Graham, would say, “in the Short Term Markets are a Voting Machine, in the Long Term they are a Weighing Machine.”
OK, in a way I realise I have contradicted what I said in Rule 3 a bit !!
5. The real money made in speculating has been in commitments showing in profit right from the start.
This is an interesting one and backs up the idea of the Stoplossers who will exit a position very quickly if it does not start to perform. I have experimented with Stoplosses many times in the past and never found it worked for me - far too often I got stopped out of great Stocks only to see them reverse up and go on to huge gains - I would rather accept that many of my Positions may go wrong for a long time and I often Average Down once they start perking up again.
This approach works with Quality Stocks - if you are buying High Risk ‘WheelieBin’ type Stocks then it might be better to use Stoplosses and Averaging Down on WheelieBin Stocks can be suicidal. My experience is that many of my Stocks start off a bit wobbly but then move on to better things - in the meantime I am picking up Dividends as well - another advantage of buying Quality. I note that Robbie Burns (the Naked Trader) has in recent years moved more to this method of cutting Losers very fast.
The way I like to look at all these Stoploss ideas is that if ever my Approach stops working then I have a ‘Plan B’ that I can start using to try and salvage the situation. I freely admit that my failures with Stoplosses in the past were probably down to poor Entries and sub-standard placing of the Stoploss Levels - I might be much better at this now as my Technical skills have improved a lot since I experimented with Stoplosses about 5 years ago.
6. As long as a stock is acting right, and the market is right, do not be in a hurry to take profits.
This is a great Rule - I totally buy into this. It is very much a theme on the Momentum thing that I go on and on about - when you have a Stock with clear upwards Momentum then you must let it run - Momentum can drive a Stock much higher than it perhaps should go based on its Fundamentals - you can of course slice a bit off if you are getting nervous.
Interesting caveat about the market being right - this is the situation pertaining at the moment really in that we are in a Bear Market. So clearly the current Market is not right but I would rather stick with my Great Stocks and use Hedging to avoid the Downside Risk - rather than selling my Great Stocks which I expect to bounce back with gusto once the malaise is over (hopefully later in 2016.)
Simply put, don’t fight the Big Mo (this applies to Downtrends also, which have a vicious Momentum of their own).
7. One should never permit speculative ventures to run into investments.
I very rarely do Short Term Trades but I think I am reasonably disciplined when I do - on the whole, everything I do is a Long Term Investment. The lesson for me here is to make sure I do stick to my discipline on any Short Term Trades - I am sure WD Readers will keep me honest !!
8. The money lost by speculation alone is small compared with the gigantic sums lost by so-called investors who have let their investments ride.
I am not sure what to make of this one - isn’t it the same as Rule 7?
9. Never buy a stock because it has had a big decline from its previous high.
I totally buy into this very important Principle - this is the “Don’t catch a Falling Knife” Rule. If you are tempted by such things, then the only acceptable method is to wait for the drops to finish and Buy in once a new uptrend has been established and make sure the Technical Factors like RSI, MACD, Bollinger Bands, Candles etc. align as well. Buying something because “it has fallen so much, it must be cheap” is how you can get very poor very fast - the Momentum I talked about earlier to the Upside is very powerful to the Downside also and the Stock can keep on dropping as you watch your Money evaporate.
10. Never sell a stock because it seems high-priced.
This is an interesting one - I have several reasons for Selling a Stock and one of them is that the Stock has got overvalued - so I guess I am in contravention of Jesse’s Rule here. In practice if a Stock has strong Upwards Momentum then I tend to let the P/E get up into the early 20s but I will probably topslice it a bit when that is the case. To me Valuation is a critical component of my Approach to Buying and Selling Stocks - I want to buy on Lowish P/Es (7 to 12 ish) and Sell on High P/Es.
Here are some links to my Blogs on Reasons for Selling stuff:
That’s it for Part 1 - more to come soon, have a Great Weekend, WD.
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