Book Summary — Reminiscences of a Stock Operator
- Author: Edwin Lefèvre
- Originally Published: 1923
- Genre: Finance
- Pages: 288
While scouring the internet for my next read on investing and trading, almost all recommendations had one book in common: Reminiscences of a Stock Operator. The biography chronicles the life of Jesse Livermore, a trader born in the late 19th century who made and lost fortunes speculating on the prices of stocks and commodities. The book contains a trove of valuable advice Jesse has accumulated throughout his time on Wall Street, particularly dealing with disciplined trading and market psychology.
Journey to Wall Street
At a young age, Jesse excelled in mental arithmetics and finished three years of arithmetics schooling in just one. Straight after school, he got a job at a stock brokerage firm as a quotation-board boy where he updated the numbers on the quotation board as soon as they appeared on the tape. He became fascinated by the behaviour of the changing prices on the tape and started predicting stock prices and recording his hits and misses.
Soon, he started utilizing his tape reading ability by betting on stock prices through bucket shops (bucket shops are unregulated gambling shops that allowed their customers to speculate on stock price movements). At the tender age of 21, he managed to amass a fortune of $25,000 (equivalent to $686,000 in 2017 dollars) and headed to New York after bucket shops refused to deal with him due to his winning streaks.
In New York, he ended up losing all his accumulated wealth as the system he had perfected with bucket shops didn’t work on exchanges. By the time an order arrives to the exchange through Jesse’s broker, the order would have transacted at a very unfavorable price due to slippage. He completely disregarded the advantage he had in bucket shops of being able to instantaneously close his positions without any market impact. Eventually however, he rebuilt his wealth by gaming several new bucket shops and resumed his career on Wall Street; this time as a better educated speculator with solid trading principles. The rest of the book follows his journey as a reborn trader and the lessons he learned from his subsequent time on Wall Street.
The Market as a Teacher
Throughout his Wall Street career, Jesse made several wrong bets that almost wiped him out. He admitted to those mistakes and referred to them as tuition fees, stressing this learning experience in the book by saying:
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.
Jesse also believes there is as much to learn from partial victory as there is from defeat. In addition, the learning process isn’t restricted to lessons on making money but also on how to avoid losing money; distinguishing between money lost due to the speculator’s fault and money lost due to developments that nobody could foresee, referring to the latter as an inconveniently timed storms.
Another learning aspect from the market according to Jesse is the fact that he has to match his brains against the brains of other traders whom he has never seen, talked to, or met. He views the market as an intellectual challenge which he is constantly trying to outsmart. However, he admits that a man may beat a stock or a group of traders at a certain time, but no man can beat the stock market. Comparing the market to a horse track, he says that a man may beat a horse race, but no man can beat horse racing.
Market Psychology & Trading
Despite changes in market micro-structure, markets remain vastly driven by herd psychology. Jesse’s trading style was heavily influenced by this observation such that his main strategy was to figure out if the market is a bull or bear market, placing his bets accordingly. It is of no surprise that one of Jesse’s favorite books is Extraordinary Popular Delusions and the Madness of Crowds by Charles Mackay.
Bull & Bear Markets
Identifying whether it is a bull or a bear market allowed Jesse to detect trends early and capture the big money in the main movements. A market’s condition (bear or bull) can be identified long before prices exhibit the corresponding movement. A trader shouldn’t blindly devote himself to the bull or bear side, his concern lies with being right.
Trend tends to be established before news is published. In bull markets, bear news is ignored and bull news is exaggerated, and vice versa. Furthermore, during booms, avoid overstaying the bull market and be aware that all trends come to an end. Also, be wary of movements due to a raid by other market participant as prices rebound the moment the raid stops. In a bear market, it is always wise to cover if complete demoralisation suddenly develops. That is, if there was a huge drop in the market and you were short, cover your shorts.
The Line of Least Resistance
To identify whether it was a bull or bear market, Jesse studied the price action of the stock in order to establish what he called the line of least resistance. According to him, prices move along the line of least resistance and stocks are never too high to buy or too low to sell.
Once the line of least resistance has been established, Jesse sums up his trading approach as follows:
Suppose line of least resistance showed a bull movement. I would buy ten thousand bales. If the market went up ten points after, I would take on another ten thousand bales. If after buying the first ten or two thousand bales, the position showed a loss, out I’d go. I was wrong, maybe temporarily, but it doesn’t pay to start wrong in anything.
Another observation by Jesse is that when a stock’s line of least resistance is upwards and it crosses a psychological barrier for the first time, the momentum tends to take the stock to an even higher barrier much faster. However, If after a long steady rise a stock turns and gradually begins to go down, with only occasional small rallies, it is obvious that the line of least resistance has changed from upward to downward.
Advice on Market Timing
Once a trader has established the current market trend and is interested in placing a bet, it is important that he times his entry to the market appropriately. For example, Jesse is most comfortable buying on a rising market as he is then assured that he is placing the right bet. He never advances until he is sure he will not have to retreat, if he can’t advance, he won’t move at all. Jesse also strongly discourages from buying on declines and counting the number of points it has sold off from the top as potential profit.
When it comes to getting out of a position, Jesse recommends doing so when you have a market with sufficient liquidity. Waiting for too long might result in trying to sell in a market that is less liquid and consequently profits will be reduced.
In addition to stock trading, Jesse also traded commodities. He describes trading in commodities as akin to a commercial venture — requiring study and observation. In his opinion, commodity prices are solely governed by the law of supply and demand, and a trader’s job is to get present and prospective facts about the supply and the demand right. Nevertheless, a trader should not completely disregard the message of the tape and should still consider general market conditions.
The Trader’s Mindset
According to Jesse, a successful trader must depend on a multitude of skills which include observation, and memory. For not only must a trader observe the market conditions accurately, but he must remember at all times what he has observed.
Traders must also have strong mathematical skills and should always try to anticipate probabilities and use them as guidance when placing their bets. Keeping in mind that a trader 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.
Experience is fundamental to becoming a successful trader. A trader must try to maximise the time he interacts with the market and learn from the experience of others as well as from his own. 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. 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.
Jesse also recommends keeping fit physically and mentally as an important advantage for a trader which is surprising given fitness wasn’t as popular in the 20th century as it is now, especially with the late 20th century’s reputation of having smoke-filled trading floors.
No matter the experience a trader can always make a losing play as trading can’t be made 100% safe. Advice is to stick to a trading plan which doesn’t have to be right all the time, for example, a plan that is correct seven out of ten times is considered sound. According to Jesse, it is simple arithmetic to prove that it is a wise thing to have the big bet down only when you win, and when you lose to lose only a small exploratory bet.
A trader doesn’t have to have a position all the time, for no man can always have adequate reasons to buy or sell daily. In addition, a trader must base his decisions on facts and facts only — he must not bet on the unreasonable or the unexpected, however certain he may feel that the unexpected happens very frequently.
Fear, Hope, and Emotions
Fear and hope are the two most prevailing emotional states in trading. When the market goes against an amateur trader, he hopes that every day will be the last day and he loses more than he should. But when the market goes his way, he becomes fearful that the next day will take away his profits and gets out too soon. The successful trader has to fight these two deep-seated instincts. Instead, he must fear that his loss may develop into a much bigger loss, and hope that his profit may become a big profit.
Fear and hope remain the same; therefore the study of the psychology of traders is as valuable as it ever was. Weapons change, but strategy remains strategy. It is important for a trader to learn to control his emotions and not let it affect his decisions. In the book, Jesse expresses surprise at how even successful traders lose control of their emotions when the market doesn’t go their way and they proceed to lose money after losing their temper.
Think for Yourself
Throughout the book, Jesse stresses his opposition to making trading decisions based on tips and encourages the reader to follow their own inclination. He recommends that traders believe in themselves and their judgment by seeking their own information and following their own methods.
Jesse also warns traders from losing their ability to think independently which can manifest in two ways; either by falling to the influence of a magnetic and persuasive personality, or by basing decisions on gratitude. Both cases can cause a trader to be in a state of uncertainty and indecision, preventing him from trading with confidence and comfort.
Finally, another way a trader can maintain his independent thinking is by ensuring he has sufficient trading capital. As without adequate margins, it would be impossible for a trader to take the cold-blooded, dispassionate attitude toward trading that comes from the ability to afford a few minor losses.
Vision without money means heartaches; with money it means achievement; and that means power; and that means money; and that means achievement.
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.
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.
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.
Bonus: A Body Language Hack
Williamson made it his practice to listen in silence, with an impassive face, to anybody who brought a proposition to him. After the man got through, Mr Stillman continued to look at him as though the man had not finished. Feeling urged to say something more, the man would offer terms much more advantageous to the Williamson.
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