The reminiscences of a stock operator, by Edwin Lefevre, has the distinction of being one of the favorite reads and most recommended books among professional stock traders. This is a look at what the book says and whether the advice it gives and lessons it imparts have relevance for investors and traders today.
Jesse Livermore and Edwin Lefevre
The main character of the book, Larry Livingstone is a pseudonym for Jesse Livermore the real person about which most of the stories relate. Over his lifetime as a speculator in stocks and commodities, Jesse Livermore gained and lost fortunes multiple times. In some instances, Larry, i.e. Jesse tells famous stories of other market traders who have gone before him.
The story starts with what he learned as a teenage clerk in a bucket shop in his home town. Bucket shops could be found in towns all over the United States. These places had ticker-tape machines fed by telegraph lines to get the prices from the main markets and a big board where the prices were written up. He describes how customers would buy and sell mostly on margin and usually end up losing.
As he studied and wrote down patterns in price movements he could see the conditions when a stock price was either about to climb or decline. He started trading and quickly accumulated profits until the bucket shop managers no longer wanted to accept his business.
This isn’t the kind of book that would be written today. On one hand, we are told about his interests in fishing and other interests in his private life, but almost out of nowhere he gets married. We are only told that because he explains how he put funds in trust as a “safe fund” for his wife and child that neither he nor she could get at. That way if he lost “his stack” again in the trading game, he would not even be able to twist her arm to set him up again in trading.
Edwin Lefevre was the real-life journalist who interviewed Jesse Livermore. One remarkable feature of the book is how the author truly speaks with the intimate knowledge of Jesse Livermore and writes the narrative as if he is Larry Livingstone, the trader, and speculator.
From the Bucket Shops of New England to Wall Street
Still, in his early 20s, Livermore realized that Wall Street was the only place for his talents. He had already exhausted the tolerance of all the bucket shop managers in the towns of New England. He became known as the Boy Plunger. A Plunger was a term used for someone who would short sell stocks. It was a term that carried a certain stain.
Many working and middle-class people in the late 19th and early 20th centuries would invest in stocks as a way of building a nest-egg. As straightforward investors, they would buy and hold solid reputable companies who paid dividends and their only risk management strategy was to hope that the stock prices would not decline.
Of course, sometimes stock prices do decline. Bull markets can turn to bear markets. Then working-class people who have saved and invested all their lives start to see the value of their nest-egg being decimated. When they also see that short-sellers are making huge profits off declining prices it is easy to see why short-sellers or plungers would be unpopular.
To read more about how short-selling works, check here.
The Boy Plunger arrives in New York and quickly finds that his system that worked so well in the bucket shops doesn’t work in Wall Street and he is losing money. His task is to work out why. He realizes that in the bucket shops with the ticker tape and the price board he could see all the information he needed and trade at the prices he saw.
However, in New York, he was watching the ticker tape but by the time he gave an order to his broker who called it through to the exchange floor, the prices would have moved.
Grades of sucker
He describes different grades of Wall Street suckers distinguished by the level of experience. The first-grade sucker knows nothing. He will usually last no more than a season. The second-grade sucker thinks he knows a lot. In fact, he only knows so much as not to lose like the first-grade sucker. He is able to recite all the rules and the don’ts but fails to learn the one important rule – don’t be a sucker! The second-rate sucker lasts usually around three and a half years.
The stock ticker
If there is one thing that comes across as a constant in the narrative, it is the dominance of the stock ticker. The stock ticker that was in use in the years covered by the book made use of Morse code transmitted by telegraph lines to relay information about each trade. For each trade, just three pieces of information were provided.
- The symbol abbreviation of the company, for example, for Union Pacific UP.
- The price at which the trade was executed.
- The number of shares that had changed hands.
At the rate these machines were operating, we can imagine that it took at least a few seconds to transmit the information about each trade. Already in the 1920s on days when there was heavy trading volume, the ticker was often hours behind the actual trades. They say that after a day of heavy trading the tickers would still be clattering away well past midnight just to catch up on all the trades of the day.
Interestingly, Thomas Edison’s first major financial success was with his improved and faster stock ticker in the late 19th century.
Throughout the book, he constantly mentions “his system”. He first developed his system in the bucket shops in his home town. He started by watching the patterns of movement in stock prices of individual stocks until he recognized what they would do before a price rise and what they would do before a price drop.
Much of the advice he gives in the book is repeated over and over.
- Determine from general conditions whether it is a bull market or a bear market.
- Trade along the line of least resistance.
- Take a position and stick with it
- The big profits are from the big swings.
- Don’t chase the last 1/8th or the first 1/8th they are the most expensive. They have cost many traders millions.
- Study general conditions not tips or special factors that affect individual stocks.
- Suckers have to trade every day.
- Only trade when conditions are right and when you are right.
- The desire for constant action is responsible for many losses.
- There is only one side to the stock market, not the bull side, not the bear side, just the right side.
- When reading the tape – if a stock doesn’t act right – don’t touch it!
- The big money is made from long-term movements.
- He made money not by thinking, but by sitting.
- Be right and sit tight.
- Many lose, not because the market beats them but because they beat themselves.
- Losing money never bothered him, if he was wrong, that bothered him.
Union Pacific and the San Francisco Earthquake
He tells the story of how on some inexplicable urge, to the repeated protestations of his friend, he started selling Union Pacific. After a day or two of trading, he was holding a short position of 5,000 Union Pacific shares.
The next day news of the San Fransisco earthquake reached the east coast. It took another three days for Wall Street to react because the prevailing sentiment was bullish. That in itself was an interesting observation. But react it did. Jesse Livermore made $250,000 profit from his short position on Union Pacific.
To read more about the San Francisco earthquake and its impact on the US economy, check here.
Corn, wheat, and oats
He tells a story of how he made big profits on wheat but was still holding a large short position on corn and the price was high and he was looking at a probable loss. He knew another rival trader had cornered all the available corn and therefore was sitting on large paper profits. Livermore knew the other trader would squeeze him to higher prices if he tried to cover his short position.
So thinking out of the box, and knowing how the commodities markets worked he started shorting oats to create a break in the price as a signal to other traders. They would conclude that corn would be next so they started selling corn. In the end, he was able to close out his oats and cover his corn with only a $3,000 loss.
Cotton and Coffee
Another story told is how he cornered the market for July cotton. When everyone else was selling he was buying, again to the dismay of his friends. In fact, it was an unexpected newspaper headline, saying how he had cornered July cotton that created the conditions allowing him to exit with a profit. This episode earned him the title King of Cotton.
However, it was his experience with coffee trading that taught him an unexpected lesson. In the early years of World War I, he saw that the conditions for coffee supply to the US would tighten because of German submarine action on shipping routes. He took huge long positions on coffee expecting the price to rise. What he did not expect was that the coffee lobby would persuade the Price Fixing Committee of the War Industries Board to fix the coffee price at an artificially low level. So even though, as he says, he was right he lost heavily.
Testing the market
We can speculate about one of the reasons why professional traders find this book so interesting. The narrative describes how after he had gained experience and when he was trading with high stakes, he would test the market. If ever he concluded that the market for a stock or a commodity was moving or ready to move in a particular direction, he would either put in a long position or a short position to see how the market reacted.
It wasn’t so much a question of whether the market was going to rise or to fall, it was always more an issue of whether the general market was a bull or a bear and what the insiders for a particular stock wanted to do.
Every company had a group of insiders, linked to the board of directors who either held stock in the company that they wanted to distribute to the broader investing public, or they wanted to accumulate more of the company’s stock for themselves.
If they were willing to support their stock and buy if the price weakened, then that was an indication that the price would rise. If on the other hand, Livermore concluded that insiders would not support their stock and would sell if the public were buying in other words that the insiders wanted to offload their stock, then he took that as a bearish signal and would sell short.
If he thought the market was ready to rise, this usually meant he thought that there was an inside clique who wanted to accumulate a larger position.
A stock manipulator
Late in his career, he was often engaged by insiders, to distribute their stock to the wider investing base of the public. The term he uses is manipulation because the process was one of careful orchestration. The idea was to build public confidence in the price so that the insiders could sell their stock at progressively higher prices to the public.
It is interesting to note that he says a few times in the book that these sales of the insiders’ positions were always to be made on the downsides of price movements. It is very interesting how as part of these deals he would take for himself options to sell the stock into the market with tranches at different price levels.
An example would be if the price was currently at $50 and the target was to get it to over $100 and to offload several hundred thousand insider-held shares. He would as part of the deal get for himself say 5,000 at $60 another 5,000 at $70, and another 5,000 and $80, etc. So he was only able to sell when the price passed that level. In this way, he was incentivized to ensure that the price rose to the target in order for him to receive all of his parts of the deal.
Parallels with today
I guess what is so interesting is how the game for him was all about guessing, second-guessing, and bluffing other large players, while the general small scale public was barely oiling the wheels.
We have to assume the same applies now. If you are a fund manager at an institution managing $ billions, you are going to be far more concerned about what other fund managers who also manage $ billions are doing. In other words, what positions your rivals are trying to build and what positions they are trying to reduce. That information is going to be far more important to you than what the public may want to do.
Remember that 90 percent of stock trading activity today is due to institutions and only 10 percent is the activity of small retail investors. The trading activity of the general public is just background noise. We are rather like sheep to be herded, and gathered around a particular attraction, and then when the time is right, properly fleeced.
As I have said many times. I am not a finance professional, if anyone reading this is, I would be very grateful for any reaction and insights you may have.
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