Can you reduce the complex business of investing to a few simple rules? It sounds too good to be true. But the story of Jesse Livermore, one of the most consistently successful traders in history, suggests that you can. More to the point, you probably should.
Born in 1877, Livermore saw his fortunes peak in 1929 with a net worth of $100m. That’s the equivalent of something comfortably above $1bn today. Unlike today’s hedge-fund and private-equity giants, he built that fortune using his own money and his own system. “The game of speculation,” wrote Livermore at the start of his book, “is the most uniformly fascinating game in the world. But it is not a game for the stupid, the mentally lazy, the man of inferior emotional balance, nor for the get-rich-quick adventurer. They will die poor.”
Consistently profitable trading – following Livermore’s rules – is perfectly possible. The reason why it is not more widely achieved is simply because it requires significant mental discipline, and not much else. The prevailing human tendency today is to look for quick wins and to avoid hard graft or any form of psychological pain, or effort. For example, it is difficult to follow a strategy that tells you to initiate a trade when the last ten trading signals from that strategy have caused you to lose money. But it could be the 11th signal that wins back all your previous losses, and more.
What is striking about the Livermore approach is that it requires no market forecasting whatsoever, no analysis of always subjective and mysterious ‘fundamentals’. As he writes himself, never trust your own opinion and back your judgement “until the action of the market itself confirms your opinion”. If this sounds like technical analysis, that’s because it is.
The essence of the Livermore strategy is what is now called trend-following: it involves waiting for the market – the underlying nature of which is irrelevant; it could be stocks, commodities, exchange rates, whatever – to display a trend, and then hitching a ride on that trend. The trend could be up or it could be down; it makes no difference to the trend-following trader.
However, what is crucially important is money management, or risk management, if you prefer. Know how much of your overall capital to deploy on a given trade, and know precisely when to get out. If you do not have an exit strategy, you do not have a strategy, full stop. Unlike Livermore, today’s trader can use automatic stop-losses at predetermined levels to pursue this objective.
Livermore began his career at the office of stockbroker Paine Webber. He moved on to trading from bucket shops – off-exchange dealerships with more than a whiff of skulduggery to them. But Livermore was not a con man. He moved on in turn to trade on the New York Stock Exchange. By 1906 he had amassed a fortune of $250,000, in part by shorting stocks ahead of the San Francisco earthquake. Not for nothing did he become known as the ‘Boy Plunger’.
During his career, Livermore made and lost several fortunes. Tragically, he died by his own hand, putting a bullet into his brain shortly after the publication of his autobiographical study How To Trade In Stocks. As he was the first to admit, he lost money whenever he failed to follow his own rules. Among these, some of the key ones were:
• Stick with the trend.
• Don’t trade when there are no obvious opportunities.
• Wait for the market to confirm your opinion before trading.
• Cut your losses, but let your winning positions run.
• Don’t follow too many markets.
• Never average down into a losing position.
None are revolutionary insights. But you would be surprised to discover how many professional investors have no interest in Livermore or in following these few essential rules. Plenty of successful traders have followed in Jesse Livermore’s wake. What they have in common is that they are all, to a greater or lesser extent, trend-followers. Ed Seykota managed to turn $5,000 into $15m over 12 years. Michael Marcus turned an initial $30,000 grubstake into $80m. Bruce Kovner, trained by Michael Marcus, is worth over $3.5bn. David Harding, founder of the UK-based trend-following firm Winton Capital, is worth over $600m.
The stories of all of these successful traders can be found at the excellent online resource for trend-followers, Turtle Trader.
At the risk of sounding hyperbolic, I would humbly suggest that trend-following is the best-kept secret in the financial markets.
• Tim Price is director of investments at PFP Wealth Management. He also edits The Price Report investment newsletter.
Category: Market updates