Trading for a Living

Excerpted from book "Trade Like Jesse Livermore"

The market is driven by psychological factors, not logic. A stock
trader is caught in a maelstrom of thoughts and emotions once he
has pulled the trigger on a trade. It is in this area that most of the
grief occurs for the trader. So far, we have studied the Livermore Trading
System’s approach to timing and money management. We’re left with this
most important section—emotional control. Once we have made a trade,
how do we control the myriad of emotions and thoughts that can easily
cause us to make bad judgments and nullify all the other good work we
have done up to the execution of the trade? No one is exempt from the
emotional part of the trading equation with its pitfalls and dangers, including
Jesse Livermore.

Livermore had an unquenchable thirst for knowledge about his chosen
profession, and all his working life he was a constant student of the
stock market. He was also a great student of the psychology of the market.
At one point, he took psychology courses at night school in New York
to better understand human nature. Livermore drew a conclusion from
his studies: There may be millions of minds at work in the market, but
there were basically only a few psychological patterns that had to be
studied and understood—since human nature in market dealings is primarily
driven by the common emotions of fear and greed, this leads to
common traits of human behavior when buying and selling. In the stock
market, this ultimately equates to common numerical and chart patterns.

Later in his life he was asked an important question by his sons, Paul
and Jesse, Jr.:

“Dad, why are you so good in the market and other people lose all
their money?”

He said, “Well, boys, I have also lost money, but each time I lost, I tried
to learn why I had lost. The stock market must be studied, not in a casual
way, but in a deep, knowledgeable way. It’s my conclusion that most people
pay more care and attention to the purchase of an appliance for their
house, or to buying a car, than they do to the purchase of stocks. The
stock market, with its allure of easy money and fast action, induces people
into foolishness and the careless handling of their hard-earned money,
like no other entity.

“You see, the purchase of a stock is simple, easily done by placing
your buy order with a broker; later a phone call to sell completes the
trade. If you profit from this transaction, it appears to be easy money with
seemingly no work. You didn’t have to get to work and labor for eight
hours a day. It was simply a paper transaction, requiring what appears to
be no labor. It gives the clear appearance of an easy way to get rich. Simply
buy the stock at $10 and sell it later for more than $10. The more you
trade, the more you made, that’s how it appears.

“Simply put, it’s ignorance.”

The boys listened attentively, but they never had any interest in trading
the market like their father.

A stock trader must constantly deal with emotions—when things go
bad, there’s often fear to deal with. Fear lies buried just beneath the surface
of all normal human life. Fear, like violence, can suddenly appear in
your life in the space of a single heartbeat, a fast breath, a blink of the eye,
the grab of a hand, the noise of a gun. When it appears, natural survival
tactics come alive, normal reasoning is distorted. Reasonable people act
unreasonably when they are afraid. And people become afraid when they
start to lose money; their judgment becomes impaired. This is our human
nature in this stage of our evolution. It cannot be denied. It must be understood,
particularly in trading the market. Sooner or later, fear will come to
visit every stock trader who actively trades the market.

The unsuccessful investor or trader is usually best friends with
hope—when it comes to the stock market, hope skips along the trader’s
path hand in hand with greed, but fear is always trailing along as well, hiding
in the shadows.

Once a stock trade is entered, hope springs to life. It is human nature
to be hopeful, to be positive, to hope for the best. Hope has been and will
always be an important survival technique for the human race. But hope,
like its stock market cousins ignorance, greed, and fear, distorts reason.

The trader must be acutely aware that the stock market only deals in
facts, in reality, in cold numbers; the stock market is never wrong—
traders are wrong. Similar to the spinning of a roulette wheel, the little
black ball tells the final outcome—not greed, fear, or hope. The final result
of stock market trading, which is posted in the newspaper at the end of
every day, is objective and conclusive, with no appeal, like pure nature in
the raw, a life and death struggle.

Livermore believed that the public wanted to be led, to be instructed,
to be told what to do. They wanted reassurance. He believed
that they would always move en masse, a mob, a herd, a group, because
people want the safety of human company. They are afraid to stand
alone because the belief is that it is safer to be included within the herd,
not to be the lone calf standing on the desolate, dangerous wolf-patrolled
prairie of contrary opinion—and the truth is that it usually is
safer to go with the trend.

This is where it gets slightly complicated for most traders. Livermore
was an independent thinker, yet he always wanted to trade along the line
of least resistance—the trend, so he was generally moving along with the
crowd, the herd, most of the time. It was when the change in trend
started to appear, the change in overall market direction—that was the
most difficult moment to catch and act upon.

He was always on the hunt for the clues to recognize a coming change
in basic trend, looking for the Pivotal Point to form. A trader can never be
come complacent. Livermore was always alert, ready, prepared to separate
himself from the popular thinking of the moment, the group thinking
that usually always drives the market, and to go in the opposite direction.
Livermore believed in cycles. There is a time when things are good
and a time when things turn bad. It is true in this life for all of us, and it is
true in the stock market. The good times are coming and so are the bad
times—the question for a successful trader is not will they come...it is
when will they come? Livermore’s conclusion—usually when you least expect
it, the trend will change.

The change in trend is the most difficult time in a speculator’s trading
life. These major changes in trends were and remain hell. But Livermore
knew these were the points where most of the money was lost, as was just
experienced from 1999 to 2002. It is best to avoid the downhill slide of
stocks, unless you have sold stocks short. There is always a way to make
money in the stock market.

With this in mind, Livermore developed two rules:

First, do not be invested in the market all the time. There are many
times when you should be completely in cash, especially when you are unsure
of the direction of the market and waiting for a confirmation of the
next move. In Livermore’s later life, whenever he deduced that a change
was coming, and he wasn’t sure exactly when or how severe the change
might be, he cashed in all his positions and waited.

Second, it is the change in the major trend that hurts most speculators.
They simply get caught invested in the wrong direction, on the
wrong side of the market. To determine if you are right in your appraisal
that a change in market trend may be coming use small position probes by
placing small orders, either buy or sell, depending on the direction of the
trend change you anticipate occurring. This will test the correctness of
your judgment. By sending out exploratory orders and investing real
money, you will get the signal that the trend is changing because each
stock purchase will be at a cheaper price than the prior purchase—the
signal—prices are dropping—time to go short.

The trader’s job is to continually observe the tape and to interpret the
tape as a person would look at a movie with no two frames exactly the
same. No two markets are ever exactly the same, but they all have similar
traits, like humans. These individual messages must be extracted from the
tape and run through your brain in a rapid fashion.

The stock market always follows the line of least resistance until it
meets with an at-first almost imperceptible force that slowly, but inexorably,
stops its upward or downward momentum. It is at these key junctures—
recognizing the Reversal Pivotal Points—being able to identify
them and not be confused by natural reactions or the appearance of Continuation
Pivotal Points—that the real money is made.

Just as the panics always encouraged Livermore to go long when
things looked the bleakest, conversely, when everything looked perfect
and blissful, it occurred to him that it might be time to go short. He tried
to see this before everyone else did. That is why he kept his own counsel
in silence and avoided, whenever possible, talking to anyone who might
alter his thinking.

Sometimes, Livermore accumulated his line of stocks at what he believed
to be the turning point in a great decline or at the crest of a mighty
upward wave. He understood that it required time for general business to
recover and for the earning power of these stocks to be reinstated, and so
he was patient and prudent in assembling his line of stocks for either a
new rally or in going short in a downward trading market.

He started trading at age 15 in the stock market. It was the focus of his
life. He was very fortunate in calling the Crash of 1907 almost to the actual
hour and very flattered when J. P. Morgan sent a special envoy to ask him
to discontinue his short selling, which he did.

On his best single day during the Crash of 1907, he made $3 million.
He was also prescient in his trading during the Crash of 1929 when he
decided to go short with the market at its very zenith, he profited by
$100 million.

But at first in the great collapse of the market in 1929, he went to
the short side too early with the motors (car companies) as they rolled
over—he lost over a quarter million dollars before he finally found the
correct Reversal Pivotal Points as the key market leaders of the time
rolled over and tumbled headlong into the great crash. He went short in
earnest at that moment and increased all his positions. During the
Crash of 1929, he made the largest amount of money he had made. He
was blamed personally by the press and the public for the crash, which
was pure nonsense. Nobody—no single person—could cause a market
to do something that it did not want to do. Nevertheless, his life was
threatened, and he was forced to protect his family with special security
measures.

By 1929, Livermore had been trading for almost 40 years and had a
finely developed intuition resulting from his enormous experience. But
he later explained that, in retrospect, in all these cases the clues were
evident in the actions of the stocks and spoke to him as clearly as can
be imagined.

For Livermore, the people who invest in the market are akin to a large
school of bait fish who have no specific leader, and they are capable of
very quick, random action whenever they fear they are in danger. In other
words, there are millions of minds involved in the stock market, these
minds form decisions based on the two main emotions in the stock market,
hope and fear. Hope is often generated by greed; fear is often generated
by ignorance.

Livermore’s main success emanated from his ability to find the main
turning points, the Reversal Pivotal Points. In the long-term trends, this is
the most crucial and important thing a stock trader must do. He was also
convinced that if a trader, during the panics and the booms, was able to
accurately find the perfect psychological moment (the pivot points) to
exit and enter the market he could amass a fortune of great proportion.
For a successful trader must be able to find and trade in the direction of
the momentum—the direction of the line of least resistance. Livermore
never had a problem in playing either side of the market (bull or bear, although
he did not use these terms) because it was only logical to him,
since he believed in cycles, that there were always going to be times to go
long and times to also go short. The market goes up a third of the time,
down a third, and sideways a third of the time.

If Livermore was exiting a long position, because he believed the
stock has topped out, it was easy for him to consider getting on the
short side of that same stock. He had no feelings for a stock, as some
people do.

For instance, if a trader has made money with General Motors on the
long side, the trader should have no emotional feelings for General Motors—
the stock has simply done what the trader deduced it would do. If
the trader can now make a profit as General Motors declines—by going
short—he should do so with no feeling toward the stock, which is after all
an inanimate thing with no feelings for the trader. There are no good
stocks, nor are there any bad stocks; there are only stocks that make (or
lose) money for the speculator.

Livermore had heard many of his fellow traders say: “That stock was
good to me.” Or “That stock cost me money, so I am staying away from it!”
The stock had nothing to do with it. Everything that happens is a result of
the trader’s judgment and no excuses are acceptable. To put it simply, it is
the trader or speculator who makes the conscious decision to enter a
trade, and it is always the trader who makes the conscious decision to exit
a trade. The judgment was either correct or it wasn’t.

All traders must beware of a kind of arrogance, for when a stock
moves against us we must decide that we were wrong and must exit that
trade instantly. Most traders forget that it is a proven fact that we will always
be wrong on some trades. It is getting out of those trades quickly
that is the key to success.

Another trap the inexperienced trader must deal with is trying to
find the exact bottom and top of a major trading cycle. Remember,
there are times when a trader must be out of the market and waiting on
the sidelines. It is virtually impossible to call the exact top and the bottom
of any market, but it is much better to err on the side of caution.
Getting out and waiting for the market to establish itself is very difficult
while you are invested, because by being invested you will have an automatic
bias toward the direction of your position. This bias stems from
the hope. If you are long, you will subconsciously favor the long side, if
you are short, you will subconsciously favor the downside. Hope lives
in us all; remember, it is human nature to be hopeful. That is why Livermore
often sold out all his positions and reevaluated the market from a
cash position. It cost him the commissions, but he viewed this as a
small insurance premium cost toward the overall profit goal. It is not
what the millions of people think about the market, or say about the
market . . . no, no, no, it is what they do about the market by their actual
buying and selling; all this is immediately revealed on the tape; the
problem is in the interpretation of this news, this evidence, as the tape
flows past the reader.

This was Livermore’s business, his life’s vocation and the thing he
most enjoyed. The work of solving the puzzle was what always fascinated
him. It was never the money—it was solving the puzzle, the money
was the reward for solving the puzzle. Going broke, which happened to
him several times in his life, was the penalty for not solving the puzzle.
The chief deception is that trading the market looks easy when it is one
of the most difficult things to do—anticipate the trend. We must be
aware of our emotional flaws and have the discipline to control and conquer
the weaknesses of our human nature. It is the most difficult task a
trader faces.

As Livermore explained to his sons: “I lost money when I broke my
own rules—when I followed my rules, I made money.”

HOW TO KEEP YOUR EMOTIONAL CONTROL IN DEALING WITH MEDIA NEWS

Livermore was always suspicious of everything he read in the newspaper
and never accepted what he read at face value. He tried to look for hidden
agendas and self-serving reasons that could have generated the articles,
no matter what paper published the information. In Livermore’s time,
many news reporters were convicted of trading against the news they
wrote about a stock. The reporters were also fed pure fiction, actual lies,
by insiders to hype the stock.

He always tried to read between the lines and formulate his own judgment;
that is why he often preferred to be alone, to formulate his own
opinions and to use his own judgment when reading the newspapers. He
did not seek the opinions of others in dealing with news releases. He tried
to look below the surface.

Livermore told a friend: “I interpret these newspaper articles in two
ways. First, I try to interpret their immediate and direct influence on the
opinions and actions of stock traders with regard to a particular stock.
Second, I watch the actual stock quotes to detect how the news has influenced
the buying and selling of specific stocks as a whole in that market
industry group. Often my interpretation of a news event is wrong. But I always
know that if the news development is of sufficient importance it will
eventually affect the tape.

“In other words, I watch the tape like a hawk to see how it is reacting
to actual news. I do not listen to people, the pundits, the reporters, the analysts
who are trying to interpret the news item and predict what will happen
to a stock, an industry group, or the overall market.
“It is my experience that it is far better to look objectively at the tape,
for the tape will provide the actual facts as to how the public is reacting to
the news. These actual facts revealed by the tape are a far better indicator
than any reporter or pundit can provide. It is up to the skillful market

trader to watch the tape and react only to what the tape is saying. Learn
how to read the tape—the truth is in the tape—listen to it. Try and avoid
the opinions of so-called-experts.”

One of the problems with looking too deeply into economic news is
that it may plant ‘suggestions’ in your mind, and suggestions can be subliminal
and dangerous to your emotional stock market health where
you have to deal in reality, not supposition. These suggestions are very
often logical, but that does not mean they are true and will necessarily
affect the market. Logic does not drive the market. It is driven by human
emotion.

CUT YOUR LOSSES, LET THE WINNERS RIDE

Note: This conversation and story are excerpted from The Amazing Life
of Jesse Livermore: World’s Greatest Stock Trader by Richard Smitten.
The conversation, held at lunch, was between Jesse Livermore, Walter
Chrysler (Chrysler Motors), Ed Kelley (head of United Fruit Co.), T. Coleman
DuPont (DuPont Family), and Colonel Ed Bradley of Bradley’s
Casino in Palm Beach (Bradley was the owner of the longest running illegal
gambling club in the United States).

“I’ve been hearing rumors on the Street about you and a wheat trade. Tell
us about it, J.L., entertain us at lunch.”

“Well, I just felt the demand for wheat in America was underestimated,
and the price was going to rise. I waited for what I call my Pivotal
Point and stepped in and bought 5 million bushels of wheat, about 7 million
dollars worth.

“I watched the market closely after the purchase. It lagged. It was a
dull market, but it never declined below where I bought it. Then one morning
the market started upwards, and after a few days the rise consolidated,
forming another of my Pivotal Points. It laid around in there for a little
while, and then one day it popped out on the upside with heavy volume.

“A good signal, so I put in an order for another 5 million bushels. This
order was filled at higher and higher prices. This was good news to me because
it clearly indicated that the market line of least resistance was upward.

“I liked the fact that it was much more difficult to acquire the second lot
of 5 million bushels. I then had filled out my predetermined target position
of 10 million bushels, so I stepped back, and kept my eye on the market. It
formed into a strong bull market and rose steadily for several months.

“When wheat rose 25 cents above my average price I cashed in. This
was a bad mistake.” Livermore paused as the lobster salads were served
and the second bottle of champagne was opened.

Walter Chrysler asked, “J.L., how the hell could it be a bad mistake to
make a profit of two and a half million dollars?”

“Because, Walter, I sat back and watched wheat rise another 20 cents
in price in three days.”

“I still don’t get it,” Chrysler said.

“Why was I afraid? Why did I sell? There was no good reason to sell the
wheat. I simply wanted to take my profit.”

“It still looks like a pretty good trade to me. I’m afraid you lost me,
J.L.,” Ed Kelley added.

“All right, let me explain. You remember that old joke about the guy
who goes to the race track and bets on the daily double and wins, then
takes all his winnings and bets it on the third race and wins. He does the
same on all the other races, and wins. Then on the eighth and final race he
takes his hundred thousand dollars in winnings and bets it all to win on a
horse, and the horse loses.”

“Yeah,” Chrysler nodded.

“Well, he’s walking out of the track and he meets a pal of his, who
says. ‘How’d you do today?’

“ ‘Not bad,’ he answers, smiling, ‘I lost two bucks.’ ”

They laughed. “That’s a good story J.L., but how the hell does it apply
to the wheat story?” Chrysler asked.

“Simple—why was I afraid of losing the track’s money, my profits? In
effect, I was simply acting out of fear. 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.”

“What’s wrong with being afraid?” Dupont asked.

“So, what did you do, J.L.?” Kelley asked.

“Well, after I booked my profit in the wheat I realized I had made a
great mistake. I had not had the courage to play the deal out to the end—
’til I got a signal to sell, a real definitive sell signal.”

“So . . . ?”

“I re-entered the market and went back at an average price 25 cents
higher than where I had sold out my entire original position. It rose another
30 cents, and then it gave a danger signal, a real strong danger signal.
I sold out near the high of $2.06 a bushel. About a week later it sold
off to $1.77 a bushel.”

“Well, you have more guts than me, J.L., and it sounds a little like
greed to me,” Ed Kelley said.

THE WILL

Livermore agreed with his friend, the gambler, Colonel Ed Bradley—after
timing and money management comes emotions. It is one thing to know
what to do. It is quite another thing to have the will to actually do it. This
is true of the stock market. This is true of life. Who knew better than Jesse
Livermore?

Having the discipline to follow your rules is essential. Without specific,
clear, and tested rules speculators do not have any real chance of
success. Speculators without a plan are like a general without a strategy,
and therefore without an actionable battle plan. Speculators without a single
clear plan can only act randomly and they must react, to the “slings
and arrows of stock market misfortune.” This leads inevitably to the
trader’s defeat.

Playing the market is partly an art form, it is not just pure reason. If it
were pure reason, then somebody would have figured it out long ago.
That’s why every speculator must analyze his own emotions to find out
just what stress level he can endure. Every speculator is different; every
human psyche is unique; every personality is unique and exclusive to an
individual. Learn your own emotional limits before attempting to speculate.
If you can’t sleep at night because of your stock market position, then
“That’s because you sell fruit, Ed. The way you know how to diagnose
the market on fruit is the way I am supposed to know how to diagnose the
stock and commodities markets, and the wheat futures market had shown
no signs of weakness when I first sold it.

“The next time I sold the wheat it was different. I could see definite
symptoms of weakness. It gave the clues, the hints, the tell-tale signs of
topping out. The tape always gives plenty of warning time for the savvy
speculator to heed.”

“Well, J.L., I like your story but sometimes I think maybe you got a
set of those lucky horseshoes up your ass, just like Ed Bradley here,”
Chrysler added.

“Well Walter, a little luck never hurt anyone.” Livermore paused and
looked around at the group. “I’d say we all had our share of luck at one
time or another.”

They all laughed.

you have gone too far. If this is the case, then sell your position down to
the sleeping level.

On the other hand, anyone who is intelligent, conscientious, and willing
to put in the necessary time can be successful on Wall Street. As long
as they realize the market is a business like any other business, they have
a good chance to prosper.

Until this latest decline in the market starting in 1999, many people
believed making money in the market was easy. Yet most Americans
work, and anyone who works knows how hard it is to consistently
make money in business, no matter what the business; it is never easy
to make money. Livermore’s friends all had their own businesses. He
would never ask his good friends like Ed Kelly, the head of the United
Fruit Company, to tell him the secrets of the fruit business or Walter
Chrysler about the automotive business. It would just never occur to
him. So, he could never understand when people asked him the question,
over and over again: “How can I make some fast money in the
stock market?”

He would smile and say to himself, “How could he possibly know how
you could make money in the market?” He always evaded the question. He
felt it was the same as asking him “How can I make some quick money in
brain surgery? Or how can I make a few fast bucks defending some person
in a murder case? He remained silent when asked because he believed
that even attempting to answer these questions affects a person’s emotions,
because you have to take a firm position and actively defend your
recommendations, which could change tomorrow, depending on the conditions
of a dynamic stock market.

But he fully understood that he was not the only one who knew that
the stock market is the world’s biggest, most profitable gold mine, sitting
at the foot of the island of Manhattan. A gold mine that opens its doors
every day and invites any and all people in to plumb its depths and leave
with wheelbarrows full of gold bars, if they can. And Livermore had done
it many times.

The gold mine is there all right, and when the bell rings at the end of
the day, someone has gone from pauper to prince, or from prince to
supreme potentate . . or stony broke. And it’s always there, the mountain
of gold, waiting for the trader to pick up the phone and pull the trigger on
a trade.

Livermore truly believed that uncontrolled basic emotions were the
true and deadly enemy of the speculator: Hope, fear, and greed are always
present, sitting on the edge of a trader’s psyche, waiting on the
sidelines, waiting to jump into the action, plow into the game and mess
things up.

This is one of the reasons he never used the words “bullish” or “bearish.”
These words were removed from his vocabulary because he believed
they create an emotional mindset of a specific market direction in a
trader’s mind. Saying it’s a bull market or a bear market causes the trader
to believe that is the direction of the market. And there is a good chance
the speculator will blindly follow that trend or direction for an extended
period of time, even if the facts change.

Well-defined trends often do not last for extended periods of time.

When people asked Livermore for a tip, he would say, the market is currently
in an “upward trend” or a “downward trend” or a “sideways
trend”—or tell them that the “line of least resistance is currently up—or
down,” as the case might be. That is all he would say and even that often
got him in trouble with the public, because he wasn’t around to tell them
when the trend changed.

This strategy left him with the flexibility to change his mind, according
to market behavior. He tried never to “predict” or “anticipate” the market,
he only tried to “react” to what the market was telling him by its
behavior.

Always be aware that when stocks decline swiftly, and abruptly,
they are being driven by fear. When they rise, they are being driven by
hope. That’s why stocks go up slowly and fall rapidly. If people are hoping
a stock will rise, they are slower to sell. If they fear the stock will
decline, they are usually fast to dump that stock. That is why declines
produce faster, more abrupt market action. So, if you play the short side
you must be ready to react to faster, more drastic market patterns and
conditions.

There is no good direction to trade, short or long, there is only the
money-making way. To sell short often goes against human nature,
which is basically optimistic and positive. In 2003, less than 4 percent of
traders ever traded the short side of the stock market. There is also no
question that it is extremely dangerous to sell short because the potential
loss is unlimited. It takes strong control of your emotions to trade
on the short side.

But the stock market moves up roughly a third of the time, sideways a
third of the time, and downward a third of the time. If you only played the
bull side of the market, you are out of the action, and your chance to make
money, two-thirds of the time. And for good or bad, Livermore was not a
man who wanted to wait, and hope, and wonder. He wanted to play the
game, and he wanted to win more times than he lost.

Livermore was fully aware that, even in his time, of the millions of
people who speculate in the stock market, few people spend full time involved
in the art of speculation. Yet, as far as he was concerned, it was a
full-time job, perhaps even more than a job, perhaps it is a vocation—
where many are called and few are singled out for real success.

It is also interesting to observe that there are now, in 2004, more mutual
funds than stocks on the NYSE. Most of these funds have strict charters
demanding that they stay no less that 95 percent invested, with no
more than 5 percent in cash. Also, in the charters of most mutual funds
the managers of the funds can only go long in their trades. So, they have
broken two of the Livermore rules–always keep a cash reserve, and always
be ready to trade either long or short and also feel free to just sit in
cash and wait for the perfect trade to appear. This is one of the reasons
the hedge funds have done so well in the last few years.

BEWARE OF STOCKS TIPS

By far, the hardest emotional pitfall a speculator must deal with is tips.
It was the main reason Livermore moved uptown to Fifth Avenue—to
get out of the reach of everyone who was trying to help him by giving
him sure things and inside information. Beware of all inside information
and tips.

Below is an excerpt from the biography Jesse Livermore—World’s
Greatest Stock Trader.

Tips come from all sources. Once, long ago, one of these tips was passed
on to me from the Chairman of a major American corporation who spoke
to me at a dinner party at my house in Great Neck.

“How are things going?” I asked him.

“Great, we’ve turned the company around, not that it was really in
trouble, but it looks like clear sailing from here. In fact, our quarterly earnings
are coming out in a week and they are going to be terrific.”

I liked him and believed him. So, the next morning I bought a thousand
shares to test it out. The earnings came in just as the chief executive
said they would. The stock rose nicely, the earnings continued to rise for
the next three quarters, and the stock rose steadily. I was lulled into a feeling
of security, as the stock continued to rise. Then it stopped and started
plummeting in the opposite direction, like a waterfall.

I called the Chairman and said: “This fall in your stock price has me
worried. What’s going on?”

He answered,”I know the price has fallen, J.L., but we consider it nothing
more than a natural correction—after all we have had a pretty damn
steady rise in the price of the stock for almost a year now.”

“How’s business?” I asked.

“Well, our sales are slightly off and that news may have leaked out,
I’m afraid. Looks like the bears got hold of that information and are hammering
the stock. Its mostly short selling, a bear raid, we think. We’ll drive
them out on the next rally, squeeze them a little, eh J.L.?”

“Are you guys selling any of your holdings?” I asked.

“Absolutely not! Where would I put my money with more safety than
my own company?”

Well, sure enough, I later found out that the insiders were busy selling
into the stock’s strength, the minute they got wind of the business going
into a slump.

I never got mad. It was my stupidity and greed. I knew that all key
executives were basically cheerleaders, and they must remain positive,
must be bearers of only good news. They could never tell shareholders
or competitors that things were not as rosy as they appeared. In fact,
it always made me smile to listen to their mendacity. The misstatements,
the lies, were just a matter of self-preservation, an essential
part of the job of a chief executive officer—at every level of power, including
politics.

But it was my self-preservation I was interested in, not the top executives
and shareholders of the companies I invested in. Therefore after a
while, and some substantial lost money, I never asked an insider again
about how their business was doing.

Why waste my time listening to half-truths, shadowy statements, inaccurate
projections, and just plain bold-faced lies when I could simply
just look at the behavior of the stock? The story was clear in the action of
the stock. The truth was in the tape for anyone and everyone to see.

I have suggested to people who were interested in the stock market
that they carry around a small notebook, keep notes on interesting general
market information and perhaps develop their own stock market
trading strategy. I always suggested that the first thing they write down
in their little notebooks was Beware of inside information . . . all inside information!
There is only one way to achieve success in speculation—through
hard work, persistently hard work. If there is any easy money lying
around, no one is going to try and give it to me—this I know. My satisfaction
always came from beating the market, solving the puzzle. The money
was the reward, but it was not the main reason I loved the market. The
stock market is the greatest, most complex puzzle ever invented, and it
pays the biggest jackpot.

And always remember: You can win a horse race, but you can’t beat
the races. You can win on a stock, but you cannot beat Wall Street all the
time—nobody can.

People always talked about my instincts, especially after the Union Pacific
story and the San Francisco earthquake. But I never thought my instincts
were that special. The instincts of a seasoned speculator are really
no different than the instincts of a farmer, like my father. In fact, I consider
farmers the biggest gamblers in the world. Planting their crops every year,
gambling on the price of wheat, corn, cotton, or soy beans, choosing the
right crop to plant, gambling on the weather, and insects—the unpredictable
demand for the crop—was more speculative. These same principles
apply to all business. So, after 20, 30, 40 years, of growing wheat or
corn or raising cattle or making automobiles or bicycles, the person naturally
gets his sixth sense, his intuition, his experience-based hunches for
his business. I consider myself no different.

The only area I may have differed from most speculators was when I
felt I was truly right, dead right, for-damn-sure right—then I would go all
the way, shoot the works. The way I did during the 1929 market crash
when I had a line of one million shares of stock out on the short side, and
every rise and fall of a single point meant a million dollars profit or loss to
me. Even then, during my biggest play, it was never the money that drove
me. It was the game, solving the puzzle, beating a game that confused
and confounded the greatest minds in the history of mankind. For me, the
passion, the challenge, the exhilaration, was in beating the game, a game
that was a living dynamic riddle, a conundrum, to all the men and women
who speculated on Wall Street.

Perhaps it was like combat is to a soldier. It’s a mental high that’s visceral,
where all your senses are pushed to the limit and the stakes are
very high.

“I told my boys—stay in the business you’re good at.” I was good at
speculating. Over the years I took many millions of dollars out of Wall
Street and invested them in Florida land, aircraft companies, oil wells, and
new miracle products based on new inventions—they were all abject failures,
disasters. I lost every cent I ever invested in them.

Just remember, without discipline, a clear strategy, and a concise
plan, the speculator will fall into all the emotional pitfalls of the market
and jump from one stock to another, hold a losing position too long, cutout
of a winner too soon, and for no reason other than fear of losing the
profit. Greed, fear, impatience, ignorance, and hope will all fight for mental
dominance over the speculator. Then, after a few failures and catastrophes,
the speculator may become demoralized, depressed, despondent,
and abandon the market and the chance to make a fortune from what the
market has to offer.

Develop your own strategy, discipline and approach to the market. I
offer my suggestions as one who has traveled the road before you. Perhaps
I can act as a guide for you and save you from falling into some of
the pitfalls that befell me.

But in the end the decisions must be your own.

Labels: Reference, Risk Management, Stock Trading System