The Training of a Stock Trader

Observation, Experience, Memory and Mathematics

In his interviews with Edwin Lefebvre, Jesse Livermore spoke eloquently of the training a would-be successful stock trader needs:

"The training of a stock trader is like a medical education.

"The physician has to spend long years learning anatomy, physiology, materia medica and collateral subjects by the dozen.

"He learns the theory and then proceeds to devote his life to the practice. He observes and classifies all sorts of pathological phenomena. He learns to diagnose. If his diagnosis is correct - and that depends upon the accuracy of his observation - he ought to do pretty well in his prognosis, always keeping in mind, of course, that human fallibility and the utterly unforeseen will keep him from scoring 100 per cent of bull's-eyes.

"And then, as he gains in experience, he learns not only to do the right thing but to do it instantly, so that many people will think he does it instinctively. It really isn't automatism. It is that he has diagnosed the case according to his observations of such cases during a period of many years; and, naturally, after he has diagnosed it, he can only treat it in the way that experience has taught him is the proper treatment.

"You can transmit knowledge-that is, your particular collection of card-indexed facts-but not your experience. A man may know what to do and lose money-if he doesn't do it quickly enough.

"Observation, experience, memory and mathematics - these are what the successful trader must depend on. He must not only observe accurately but remember at all times what he has observed. He cannot bet on the unreasonable or on the unexpected, however strong his personal convictions may be about man's unreasonableness or however certain he may feel that the unexpected happens very frequently. He must bet always on probabilities - that is, try to anticipate them. Years of practice at the game, of constant study, of always remembering, enable the trader to act on the instant when the unexpected happens as well as when the expected comes to pass.

"A man can have great mathematical ability and an unusual power of accurate observation and yet fail in speculation unless he also possesses the experience and the memory. And then, like the physician who keeps up with the advances of science, the wise trader never ceases to study general conditions, to keep track of developments everywhere that are likely to affect or influence the course of the various markets. After years at the game it becomes a habit to keep posted. He acts almost automatically. He acquires the invaluable professional attitude and that enables him to beat the game-at times! This difference between the professional and the amateur or occasional trader cannot be overemphasized. I find, for instance, that memory and mathematics help me very much. Wall Street makes its money on a mathematical basis. I mean, it makes its money by dealing with facts and figures.

"When I said that a trader has to keep posted to the minute and that he must take a purely professional attitude toward all markets and all developments, I merely meant to emphasize again that hunches and the mysterious ticker-sense haven't so very much to do with success."

 

Trading Rules

Jesse Livermore's Stock Trading Rules

All successful stock and commodity traders have rules for buying and selling. Many traders today still use the trading rules Jesse Livermore first devised almost a century ago.

Jesse Livermore constructed his rules over several years while he learned by trial and error what worked on the markets. He was guided by one of his favorite principles:

"There is nothing new in Wall Street. There can't be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again."

Trading Rules

• Buy rising stocks and sell falling stocks.
• Do not trade every day of every year. Trade only when the market is clearly bullish or bearish. Trade in the direction of the general market. If it's rising you should be long, if it's falling you should be short.
• Co-ordinate your trading activity with pivot points.
• Only enter a trade after the action of the market confirms your opinion and then enter promptly.
• Continue with trades that show you a profit, end trades that show a loss.
• End trades when it is clear that the trend you are profiting from is over.
• In any sector, trade the leading stock - the one showing the strongest trend.
• Never average losses by, for example, buying more of a stock that has fallen.
• Never meet a margin call - get out of the trade.
• Go long when stocks reach a new high. Sell short when they reach a new low.

Other Useful Trading Guidance

• Don't become an involuntary investor by holding onto stocks whose price has fallen.
• A stock is never too high to buy and never too low to short.
• Markets are never wrong - opinions often are.
• The highest profits are made in trades that show a profit right from the start.
• No trading rules will deliver a profit 100 percent of the time.

 

Speculation Defined

Graham and Dodd's Definition of Speculation

In their 1934 classic text, Security Analysis, Benjamin Graham and David Dodd provided a general definition of speculation: "An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative."

By this definition, most people who buy stocks are speculators. We can attempt to sharpen Graham and Dodd's definition by including time-scale. Speculators are not interested in putting their money into a stock or commodity for a long time. They want to see a good profit quickly - on a time scale of minutes to months. If their money does not quickly perform well in a situation, they move it into another situation.

In pursuit of greater gain, speculators take greater risks with their capital than people who put their money into Savings & CD Accounts.

Jesse Livermore's Definition of Speculation

Jesse Livermore, the 20th century's most (in) famous speculator provided his own definition of speculation - preceding Graham and Dodd's by several years. In Reminiscences of a Stock Operator, under his pseudonym of Lawrence Livingston, he said: "The speculator is not an investor. His object is not to secure a steady return on his money at a good rate of interest, but to profit by either a rise or a fall in the price of whatever he may be speculating in."

Intelligent Speculation

Benjamin Graham and Jesse Livermore both had more to say about speculation: Benjamin Graham continued - this time in The Intelligent Investor:

Outright speculation is neither illegal, immoral, nor (for most people) fattening to the pocketbook. More than that, some speculation is necessary and unavoidable, for in many common-stock situations there are substantial possibilities of both profit and loss and the risks therein must be assumed by someone.

There is intelligent speculation as there is intelligent investing. But there are many ways in which speculation may be unintelligent. Of these the foremost are:

• speculating when you thing you are investing
• speculating seriously when you lack proper knowledge and skill for it
• risking more money in speculation than you can afford to lose

Livermore said:

• The game of speculation is the most uniformly fascinating game in the world. But it 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.
• Speculation is a hard and trying business, and a speculator must be on the job all the time or he'll soon have no job to be on.

 

Learning Stock Trading

• A lesson I learned early is that there is nothing new in Wall Street. There can't be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again.
• I think the clearest summing up of the whole thing was expressed by Thomas F. Wood lock when he declared: "The principles of successful stock speculation are based on the supposition that people will continue in the future to make the mistakes that they have made in the past."
• It takes a man a long time to learn all the lessons of all his mistakes. They say there are two sides to everything. But there is only one side to the stock market; and it is not the bull side or the bear side, but the right side. It took me longer to get that general principle fixed firmly in my mind than it did most of the more technical phases of the game of stock speculation.
• I didn't have as many interesting experiences as you might imagine. I mean the process of learning how to speculate does not seem very dramatic at this distance. I went broke several times, and that is never pleasant, but the way I lost money is the way everybody loses money that loses money in Wall Street. Speculation is a hard and trying business, and a speculator must be on the job all the time or he'll soon have no job to be on.
• It took me five years to learn to play the game intelligently enough to make big money when I was right. There was much more to the game of stock speculation than to play for fluctuations of a few points.
• I can't tell you how it came to take me so many years to learn that instead of placing picking (small) 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.
• 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!
• Slow as my progress seems now, I suppose I learned as fast as I possibly could, considering that I was making money on balance. If I had lost oftener perhaps it might have spurred me to more continuous study. I certainly would have had more mistakes to spot. But I am not sure of the exact value of losing, for if I had lost more I would have lacked the money to test out the improvements in my methods of trading.
• And right here let me say one thing: After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight! It is no trick at all to be right on the market. You always find lots of early bulls in bull markets and early bears in bear markets. I've known many men who were right at exactly the right time, and began buying or selling stocks when prices were at the very level which should show the greatest profit. And their experience invariably matched mine that is, they made no real money out of it. Men who can both be right and sit tight are uncommon. I found it one of the hardest things to learn. But it is only after a stock operator has firmly grasped this that he can make big money. It is literally true that millions come easier to a trader after he knows how to trade than hundreds did in the days of his ignorance.
• One of the most helpful things that anybody can learn is to give up trying to catch the last eighth or the first. These two are the most expensive eighths in the world. They have cost stock traders, in the aggregate, enough millions of dollars to build a concrete highway across the continent.
• Without faith in his own judgment no man can go very far in this game. That is about all I have learned to study general conditions, to take a position and stick to it. I can wait without a twinge of impatience.
• Obviously the thing to do was to be bullish in a bull market and bearish in a bear market. Sounds silly, doesn't it? But I had to grasp that general principle firmly before I saw that to put it into practice really meant to anticipate probabilities. It took me a long time to learn to trade on those lines. But in justice to myself I must remind you that up to then I had never had a big enough stake to speculate that way. A big swing will mean big money if your line is big, and to be able to swing a big line you need a big balance at your broker's.
• I didn't wait to determine whether or not the time was right for plunging on the bear side. On the one occasion when I should have invoked the aid of my tape-reading I didn't do it. That is how I came to learn that even when one is properly bearish at the very beginning of a bear market it is well not to begin selling in bulk until there is no danger of the engine back-firing.
• The public is so often whipsawed that one marvels at their persistence in not learning their lesson.
• What I have told you give you the essence of my trading system as based on studying the tape. I merely learn the way prices are most probably going to move. I check up my own trading by additional tests, to determine the psychological moment. I do that by watching the way the price acts after I begin.
• I have learned that a man may possess an original mind and a lifelong habit of independent thinking and withal be vulnerable to attacks by a persuasive personality. I am fairly immune from the commoner speculative ailments, such as greed and fear and hope. But being an ordinary man I find I can err with great ease.
• To learn that a man can make foolish plays for no reason whatever was a valuable lesson. It cost me millions to learn that another dangerous enemy to a trader is his susceptibility to the urgings of a magnetic personality when plausibly expressed by a brilliant mind. It has always seemed to me, however, that I might have learned my lesson quite as well if the cost had been only one million. But Fate does not always let you fix the tuition fee. She delivers the educational wallop and presents her own bill, knowing you have to pay it, no matter what the amount may be. Having learned what folly I was capable of I closed that particular incident.
• A man must know himself thoroughly if he is going to make a good job out of trading in the speculative markets. To know what I was capable of in the line of folly was a long educational step. I sometimes think that no price is too high for a speculator to pay to learn that which will keep him from getting the swelled head.