BseNse

 Understanding Stock Trading

1. Understanding Technical Stock Trading

n How to Trade in Stocks, Jesse Livermore discussed "the folly of trying to find out a good reason why you should buy or sell a given stock."

He wrote in the context of U.S. stocks, whose four major sectors - including steel makers - had risen after World War 2 began. His thoughts at that time are as relevant today as they ever were.

While other sectors continued to advance, Livermore noticed that U.S. steel stocks had stopped rising. He suspected there must be a good reason for the steel stocks to have stopped rising, but he didn't know what it was.

It was not until four months later that the public was given the facts and the price action of the steel stocks - which had by now fallen 26 to 29 points - was finally explained. It turned out that the British and Canadian governments had been selling large volumes of shares in U.S. steel makers. (Presumably to fund their war efforts)

The Action of the Market should be Reason Enough

 

"If you wait until you have the reason given, you will have missed the opportunity of acting at the proper time!"

"The only reason an investor or speculator should ever want to have pointed out to him is the action of the market itself."

"Whenever the market does not act right or in the way it should - that is reason enough for you to change your opinion and change it immediately."

"Remember: there is always a reason for a stock acting the way it does."

"But also remember: the chances are that you will not become acquainted with that reason until some time in the future, when it is too late to act on it profitably."

2. Understanding Fundamental Stock Trading

People sometimes make the mistake of believing that Jesse Livermore was a purely technical trader.

It's true that Jesse would try to exploit the market using his technically based tape-reading skills and it's also true he wouldn't worry too much about the reasons behind the numbers on the tape.

At other times though - as he explained in Reminiscences of a Stock Operator - he would act on his understanding of the fundamental economics of a situation

The United State World Trade Corporation operated around the world. It owned shipping lines, coffee plantations in Guatemala, hydroelectric plants in Bolivia, banks in Peru and conducted a huge export business. In a bear market, the public remembered that USWT's business was spread all over the world and so could divide its risks. The company continued to pay its quarterly dividend.

The bear market developed with severe declines. USWT stock descended in a leisurely manner. One day when the rest of the market showed an improvement, USWT stock suddenly fell five points on the highest volume in months.

USWT's president and directors assured the public and the press that nothing was wrong and denied rumors that the dividend would be cut.

Instead of rallying, however, the stock fell further the next day and continued falling.

Then, to a chorus of outrage, the directors announced that there would be no quarterly dividend.

Why did USWT suddenly fall?

Jesse Livermore had been analyzing the export trade and conditions in South America and the Far East and had concluded that the economic conditions were not favorable and were going to worsen.

He looked for the stock that would corroborate and justify his opinion of basic conditions. There was USWT, whose price was falling, but had not been as badly sold down as many other stocks.

He got USWT's annual reports for three years and then, when he understood the company's finances as well as the underlying conditions in every one of the company's lines of business; he sold short ten thousand shares of the stock.

He began at 110. The next morning, he read the president's statement:

"I'll tell you that there has been no talk whatever about it, and no desire or intention of either reducing or passing the next dividend. I hope we may never have to do that."

This had the effect of making Livermore sell another ten thousand shares short, and the price broke so badly that he was encouraged to put out an additional short line of ten thousand shares on the third day.

Now the share price had fallen to the 80s. There was no inside support to speak of, and the room-traders on the floor saw it and sold so recklessly that the stock had a good rally on their covering.

Then come the last grand drive, at the opening, on the day after the directors' meeting. Livermore took advantage of the big collapse to cover his shorts at a little above 60. He commented:

"I made a killing on that stock. I didn't need any inside tip."

Edwin Lefebvre said to Livermore:

"And the beauty of it is that Wall Street accused the directors of speculating in their own shares. Do you remember the shriek the newspapers let out when the stock broke after the president came out with a statement that they were not going to pass the dividend? They did not know it was your selling. I happen to know that the decision to pass the dividend was not reached by the directors until two minutes before they took a vote on it."

"Well," said Livermore, "I reached it for them two weeks before they voted... I knew they must [pass the dividend]. I knew they must; if not this time, three months later."