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So let’s get going.
During the recent holidays, I read 1929 – The Inside Story of the Greatest Crash in Wall Street History by Andrew Ross Sorkin. I thoroughly enjoyed the book, though the author focuses more on the personalities and individuals involved than on a detailed analysis of the financial and economic forces at work. Nevertheless, I would recommend it to anyone interested in markets and trading.
Two of Sorkin’s comments that genuinely struck a chord (among many) were:
“Markets are not contests of virtue and honour. By pitting the greed of their participants against one another, they wend their messy way towards fair and reasonable prices. Over time, in the aggregate, the system works, even if at any given moment, it can look like pure chaos.”
And (whilst we are all debating whether AI is a bubble):
“No matter how many warnings are issued or how many laws are written, people will find new ways to believe that the good times can last forever. They will dress up hope as certainty. And in that collective fever, humanity will again and again lose its head.”
Jesse Livermore, known as the Boy Plunger, plays a significant role in the book, earning $100 million by selling stocks short during the 1929 crash.
Livermore made and lost many fortunes during his trading career, and he lost all his gains from 1929 during the stock market rallies of 1932 and 1933, leaving him penniless. He ultimately shot himself in the cloakroom of the Sherry-Netherland Hotel in November 1940. In a letter to his wife, he wrote, “Things have been bad with me. I am tired of fighting. Can’t carry on any longer.”
Livermore had amassed a $10 million fortune trading agricultural commodities in the early 1920s, when he took large short positions in wheat and corn on the Chicago Board of Trade. However, he soon lost everything when he traded cotton from the long side. It was the second time in his career that he had lost everything trading cotton, breaking his own rules by averaging down rather than accepting a small initial loss.
Sorokin’s book features some excellent quotes from Livermore that remain just as relevant today as they were then. Livermore once told his eldest son:
“Every stock is like a human being: it has a personality, a distinctive personality: aggressive, reserved, hyper, high-strung, volatile, direct, logical, predictable, unpredictable. I often studied stocks like I would study people; after a while, their reactions to certain circumstances become more predictable.”
The same applies to a commodity: each has its own character. By thoroughly understanding your commodity, you can anticipate how it will react in different situations.
Livermore had some important rules when he traded. Sorkin quotes two of them:
“Take small losses. Profits always take care of themselves. But losses never do. The speculator has to ensure himself against considerable losses by taking the first small loss. In doing so, he keeps his account in order so that, at some future time, when he has a constructive idea, he will be in a position to enter another deal.”
And:
“Don’t trade every day. There are only a few times every year, possibly four or five, when you should allow yourself to make any commitment at all.”
However, perhaps the most memorable quote in Sorkin’s book is not from Livermore but from Ernest Hemingway’s 1926 novel, The Sun Also Rises. The character Bill asks Mike Campbell, “How did you go bankrupt?” and Mike responds, “Two ways. Gradually and then suddenly.”
Sorkin recounts an intriguing anecdote about a conversation Livermore had with Walter Crysler and others regarding his latest wheat trade. Livermore lamented that he had made a stupid mistake by cashing out a wheat position after the price increased by 25 cents a bushel.
Crysler asked him, “How the hell could it be a bad mistake to make a profit of two and a half million dollars?”
“Because, Walter, “he replied,” I sat back and watched wheat another twenty cents in price in three days.”
“I still don’t get it,” Chrysler said.
Livermore explained that he sold his position out of fear.
“Why was I afraid?” he said. “There was no good reason to sell the wheat. I wanted to take my profit. I was in too big a hurry to convert a paper profit into a cash profit. I had no other reason for selling out that wheat, except that I was afraid to lose the profit I had made.”
Sorkin concludes, “The best traders, Livermore understood, were fearless.”
But was Livermore fearless, or, as some commentators have suggested, not a trader at all but a compulsive gambler? Was he, as one of my friends proposed, as addicted to trading as an alcoholic is to alcohol?
He might have been, but that does not explain why he repeatedly lost everything by ignoring his own rules. It sometimes feels as if he wanted to lose everything to face the challenge of starting again.
This has prompted some commentators to suggest he may have had bipolar disorder. Livermore certainly experienced repeated cycles of intense elation and energy, followed by periods of profound depression, and, ultimately, he took his own life. It was during these depressive episodes that he lost everything.
However, what interests me is why he ignored his own rules during these periods, such as averaging down in his disastrous cotton trades.
I suppose we may never find out, but his life and trading demonstrate why you must have strict risk management rules – and why you should adhere to them.
Further reading
Reminiscences of a Stock Operator by Edwin Lefèvre is a fictionalised autobiography of Livermore’s life, published in 1923. It remains one of my favourite books on trading. If you haven’t read it and are involved in markets and trading, I recommend you move it to the top of your reading list.
I also recommend ‘Jesse Livermore Boy Plunger’ by Tom Rubython, with a foreword by the legendary hedge fund manager Paul Tudor Jones.
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