winners—as long as the stock is acting right, do not be ina hurry to take a proﬁt. You must know you are right in your basic judgment, or you would have no proﬁt at all. If there is nothing basicallynegative, well then, let it ride! It may grow into a very large proﬁt. Aslong as the action of the overall market and the stock does not give youcause to worry, let it ride—have the courage of your convictions. Staywith it!When you are in proﬁt on a trade, you never need to be nervous. Livermore could have a line of a hundred thousand shares out on a singlestock play and sleep like a baby. Why? Because he was in proﬁt on thattrade. He was simply using the track’s money—the stock market’s money.His attitude was that if he lost all his proﬁt—well then he had lost moneyhe never had in the ﬁrst place, since he did not count the money as proﬁtuntil he sold the stock and converted it to cash.
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Proﬁts Take Care of Themselves—Losses Never DoNever confuse this approach of letting the position ride with the “buyand hold forever” strategy. How can any trader know what will occurfar into the future? Things change: Life changes, relationships change,health changes, seasons change, your children change, your loverchanges, why shouldn’t the basic conditions that originally caused youto buy a stock change? To buy and hold blindly on the basis that it is agreat company, or a strong industry, or that the economy’s generallyhealthy was to Livermore the equivalent of stock-market suicide. Hesaid: “There are no good stocks—there are only stocks that makeyou money.”As already discussed, one of the most important points in buying astock was to try and buy as closely as possible to the Pivotal Point or theContinuation Pivotal Point. It was from this point that the key decisionsare made. If the stock advanced from the Pivotal Points, you can hold itand relax, because from then on you are playing with the house’s money,not your own capital. If the stock pulls away from the Pivotal Point in theopposite direction of the purchase, the experienced trader knows to automatically sell his position. It therefore becomes the trader’s biggest job toﬁnd the Reversal Pivotal Points and Continuation Pivotal Points. This isthe constant money management rule you must never break: cut yourlosses, let your proﬁts run.Stick with the winners—let them ride until you have a clear reasonto sell.
MONEY MANAGEMENT RULE 5: PUT HALFTHE PROFIT FROM A WINDFALL TRADE IN THE BANKLivermore recommended parking 50 percent of your proﬁts from a successful trade, especially where you doubled your original capital. Setthis money aside, take it out of the stock market so you have to make aconscious effort to put it back in. Put it in the bank, hold it in reserve,lock it up in a safe deposit box, stuff it in your mattress—just put itsomewhere safe. Like winning in the casino, it’s a good idea, now andthen, to take your winnings off the table, and turn them into cash. Thereis no better time then after a large win on a stock. Cash is your secretbullet in the chamber.The single largest regret I have ever had in my ﬁnancial lifewas not paying enough attention to this rule.—Jesse Livermore
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Here is a summary of Jesse Livermore’s money management rules:1. Use probes—don’t buy your entire position all at one time;2. Never lose more than 10 percent of your investment;3. Always keep a cash reserve;4. You need a reason to buy a stock and you need a reason to sell;5. Put half the proﬁt from a windfall trade in the bank.
ADDITIONAL ADVICEStay Away from Cheap StocksOne of the greatest mistakes that even experienced investors make is buying cheap securities just because they are selling at a low price. Althoughin some instances stock demand may push the stock from a small pershare price of say, $5 or $10 a share to over $100, many of these low-pricedstocks later sink into oblivion by going into receivership, or else theystruggle for years and years, with only the slightest prospect of ever returning a proﬁt to their shareholders.In selecting securities, it is essential for an investor to determinewhich industries or groups are in the strongest position, which are lessstrong, and which groups are comparatively weak, very weak, etc. Thespeculator should not plunge into cheap stocks in depressed industrygroups just because the stock may appear to be a bargain. Stay with thepowerful, healthy Industry Groups.
Keep Your Funds Liquid and Working for YouPerhaps nothing has contributed to the traditional poor success of thepublic in the investment markets as much as this fact—the average market investor does not keep his investment and speculative funds in propercirculation. The public is usually in a permanent loaded-up or tied-up condition, buried in a stock or a number of stocks with no cash or buyingpower held in reserve.If the public observes a certain stock that may advance a few points amonth, are they interested? No, they want something that moves morequickly. Yet in a few months they will probably wake up to see the stocksthey refused to buy now selling for 20 points higher, while their cheap,volatile stocks, which they actually purchased, are selling at less than theprices they paid for them.
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Disregard the Action of InsidersNever pay any attention to the actions of insiders—this includes companydirectors and management. Insiders are commonly the absolute worstjudges of their own stock. They usually know too much about theirstocks, and they are too close to observe the weaknesses. Key executivesalso are usually ignorant about the stock market, especially market technical indicators and group movement. They are often reluctant to admitthat the stock market is a specialty business and is an entirely differentbusiness from their own. In other words, you can be an expert in radiobroadcasting or selling automobiles, or the manufacture of steel or pharmaceuticals, and most likely not know anything about trading stocks, especially in a volatile stock market as we had in the late 1990s and early inthe new millennium.
Disregard Any Statement Made by Key ExecutivesThe chief executive ofﬁcer of most companies is little more than a cheerleader who has only one job with regard to the market. He must assureand reassure the shareholders, including the mutual funds and potentialfuture shareholders, that everything is ﬁne—if sales are down, he tells theshareholders that the decline is nothing more than a slight problem due tosome temporary reason like seasonality, terrorism or competitors’ lowering their prices. If proﬁts are down, he assures the shareholders there isnothing to worry about, since the company has already reacted and madeadequate plans to recapture their proﬁtability.
Before Buying a Stock Establish Proﬁt Target—Risk/Reward RatioThe intelligent trader pays a lot of attention to the ratio of potential proﬁtand the size of his overall investment. If a stock was trading at $200 andyou are expecting a 20-point move or 10%, then you know you will have toput up $200,000 to make $20,000. This was not appealing for Livermore,because for him the risk/reward ratio was out of balance. No matter howgood a trader you are, stock market losses are inevitable and must be considered as part of a trader’s operating expenses, along with interest, brokerage fees, and capital gains tax. Few stock traders establish arisk/reward ratio before they enter a trade. It is essential to try to do thisin order to have a speciﬁc money management plan.Livermore was a lot less active in his trading than people thought. Infact, in his later life he was only interested in the “essential move,” the important swing in the stock price. This often took extra patience in waiting
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for all the factors to come together to a focal point, where he felt as muchas possible that everything was in his favor: the direction of the overallmarket, the industry group, the sister stock activity and, ﬁnally, an important Pivotal Point.A famous misunderstood quote of Livermore was: “It was the sittin’and the waitin’ that made me the money.”He did not mean the sitting and waiting after the stock was purchased—he meant before he pulled the trigger—that’s when the tradermust have the patience to sit and wait for all factors to come together tomerge into the perfect trade, or as perfect as possible.Remember, it is very difﬁcult to work your way back from a devastating loss—this is true no matter what anyone tells you. Don’t wind up without cash, like the merchant with no inventory—that’s the same as a stocktrader with no cash—out of business.
Always Establish a Stop before Making a TradeWhen you purchase a stock, you should always have a clear price target ofwhere to sell if the stock moves against you. And you must obey yourrules! Never sustain a loss of more than 10% of your invested capital.Losses are twice as expensive to make up, as previously explained. Thispoint can not be made often enough.Always establish your stop before making the trade. This is anotherreason for buying on the Pivotal Point—it always gives the trader a clearpoint of reference. The Pivotal Point acts as a place to establish the stoploss point—the spot for the trader to close out the trade if things goagainst him.Before making a trade, most stock traders do not take the time to observe the following rules:• Decide on the potential of the trade versus the size of the investment—if it is a large investment with a small potential return, thenpass. The trader should see a clear proﬁt potential.• Before you buy, make sure that you are buying at a crucial PivotalPoint, and use this as the spot to establish your exit point—your stoploss point if the trade goes bad. Write this number down and honorit—cut your losses—this is the most important thing for the trader toknow, even if you get whipsawed and it rallies right back. It did not dowhat you expected it to do at the time you pulled the trigger–this isthe most important thing to remember.• Make sure all things are in your favor, market direction, group direction, sister stock direction and the exact timing is in place.
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• At this point, the trader must then assume the status of an automaton,a robot, and he must then follow his rules.Remember that no trader’s judgement is infallible; if it were alwayscorrect, that person would soon be the richest on this planet. But it is notthe case—we all make mistakes, and we will continue to make mistakesin our lives and in the stock market! The rewards can be enormous if wecan learn to “cut the losses quickly and let the proﬁts ride.”
Points Are a Key to Money ManagementLivermore wanted at least the opportunity of a 10 point gain in any stockhe invested in.Potential proﬁt points were key in his trading. He was well aware thatif a stock goes from $10 to $20 it is a 100 percent gain, whereas a stockthat goes from $100 to $200 is a hundred point gain, as well as a hundredpercent increase in value.He always bought in round lots and used his probing technique to buy:1. An initial position of 20 percent,2. A second position of 20 percent,3. A third at position of 20 percent, and4. A ﬁnal purchase of 40 percent, with all purchases being at a higher
price and therefore higher cost.This proved to him that the stock was moving in the direction he wantedit to.As previously explained, the main challenge for the trader is to identify the current market leaders and to spot the new market leaders whoare waiting to take over from the current ones. During major shifts andchanges in market direction, it is of paramount importance for the traderto observe the leaders that are being driven out and identify the newstocks that will assume leadership in the future.It is usually always best to go with the strongest stock in the strongestgroup—do not look for the cheapest or the laggard stock that has not yethad his turn to move in the group—always go for the strongest most dominant stock in the group.
Livermore’s Method of PyramidingThe trader must learn: You never average down.That is, if the stock you bought goes down in price—do not buy any
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more and try to average your price—it hardly ever works. But whatdoes often work is “averaging up” in price—buying more as the stockgoes up in price. But this can be dangerous also, so try to establish yourmain position at the beginning, at the initial Pivotal Point, and then increase it at the Continuation Pivotal Point—providing the stock comesout of the consolidation with strength. The trader must wait until thestock has proven it is going to break out on the strong side of the Continuation Pivotal Point; until the stock declares itself, it is always a risk. Atthese junctures the trader must watch like a hawk and stay poised, butnot biased by hope.The ﬁnal time a trader can pyramid is when a stock breaks out to aclear new high, especially if it moves on heavy volume (see Figure 5.1);this is a very good sign because it most likely means that there is no moreoverhanging stock to stop the progress of the stock for a while.All pyramiding in the stock market is a dangerous activity, and anyonewho tries it must be very agile and experienced, for the further a stockmoves in its rise or decline the more dangerous the situation becomes. To
Figure 5.1 Break-out to a new high on heavy volume.
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offset the risk, Livermore tried to restrict any serious pyramiding to thebeginning of the move. He found it unwise to enter a pyramiding action ifthe stock was far from the Pivotal Point base—better to wait for the nextContinuation Pivotal Point or the break-out to a new high.The trader must always remember there are no ironclad rules to thestock market, the main objective for the stock speculator is to try andplace as many factors in his favor as he can. And even with these in place,the trader will still be wrong on many occasions, and he must react by cutting his losses.Here is a money management rule that cannot be stated often enough:A trader should always keep some cash in reserve for those incrediblemoments in trading the market when all the factors come together to formthe “Supreme Trade at the Perfect Moment” such as occur at the zenith ofbull markets and the nadir of panics. Many of these trading moments haverecently occurred in 2003, and more still remain for 2004. There is no better feeling than having a strong army of cash standing by, waiting for yourcommand to move into action.
Proﬁts: The Spine of Every StockThere is no magic about achieving success in the stock market. The onlyway for anyone to succeed in investments is to investigate before investing; to look before he leaps; to stick to the fundamentals of his own personal list of rules, and disregard everything else. But, of course, ﬁrst hemust establish his list of trading rules. Jesse Livermore was one of themost successful traders in history. In this section, the trader is getting alook at his money management rules.Livermore would say to today’s trader: “Take my rules and try them. Iestablished them after having made many mistakes and thousands ofhours of analysis and they work. If I can save you the pain and expense Iendured, I will be happy to have done so.”Every trader must also understand that, in the end, in the ﬁnalanalysis, when the dust settles on a stock, it is the earnings—proﬁts,and proﬁt potential—that actually establish the ﬁnal price of the stock.This happens when the emotions are wrung out and reality ﬁnally doessettle in. But the trader must also understand that it is always hope andgreed that grease the skids, lubricate the wheels of volatility on thestock’s journey. The promise of superior earnings may have driven thestock in its history. But in the ﬁnal analysis, it is real proﬁts and real results that eventually cause the price of stocks to settle. Reality will always eventually set in to produce a ﬁnal conclusion for the industrygroup and any particular stock. This will be revealed to the skilled technical trader as it occurs.
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Don’t Give Your Money to Others to TradeIt has become apparent in today’s modern scandal-ridden markets thatthere is no security or safety in trading in the shares of large blue-chipcompanies or listening to highly accredited analysts, or trusting old, steadfast mutual funds. Where big money is concerned, there is always the danger of illegal activities lurking in the background. And there is no moremoney at stake than in the American stock markets.The gangsters, the con men, the thieves, the swindlers, the grifters, allknow where the money is and are always thinking of ways to help themselves to the stock trader’s money. This comes as an additional burden inthe ﬁeld of stock trading, which is a most difﬁcult ﬁeld to begin with—aplace where only the skillful, disciplined trader has a chance.Here is one of Livermore’s famous sayings: “If I am going to lose mymoney in the stock market, as so many people do . . . then I would preferto lose it myself. I do not need a broker to lose it for me.”When you are handling surplus income, do not delegate the task toanyone. Whether you are dealing in millions or in thousands, the sameprincipal lesson applies. It is your money. It will remain with you just solong as you guard it. Faulty speculation is one of the most certain ways oflosing it.Blunders by incompetent speculators and traders cover a wide scale.Livermore warns strongly against averaging losses. That is a most common practice. Great numbers of people will buy a stock, let us say at 50,and 2 or 3 days later if they can buy it at 47 they are seized with the urge toaverage down by buying another hundred shares, making an average priceof 48 on all.Having bought at 50 and being concerned over a three-point loss on ahundred shares, what rhyme or reason is there in adding another hundredshares and having the double worry when the price hits 44? At that point,there would be a $600 loss on the ﬁrst hundred shares and a $300 loss onthe second hundred shares.If one is to apply such an unsound principle, he should keep on averaging by buying 200 shares at 44, then 400 at 41, 800 at 38, 1600 at 35,3200 at 32, 6400 at 29, and so on. How many speculators could standsuch pressure? Yet if the policy is sound, it should not be abandoned. Ofcourse, abnormal moves such as the one indicated do not happen often.But it is just such abnormal moves against which the speculator mustguard to avoid disaster.So, at the risk of repetition and preaching, avoid averaging down. Livermore received one sure tip from a broker concerning a margin call:When the margin call reaches you, close your trade—never meet a margincall. This proves you are on the wrong side of the market. Why send good
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money after bad? Keep that good money for another day. Risk it on something more attractive than an obviously losing deal.A successful businessman extends credit to various customers, buttypically would not sell his entire output to one customer. The larger thenumber of customers, the more widely the risk is spread. Just so, a personengaged in the business of speculation should risk only a limited amountof capital on any one venture. As stated, cash to the speculator is like merchandise on the shelves of the merchant.One major mistake of all speculators is the urge to enrich themselvesin too short a time. Instead of taking 2 or 3 years to make 500 percent ontheir capital, they try to do it in 2 or 3 months. Now and then they succeed.But do such daring traders keep it?They do not. Why? They do not take some money off the table fromtime to time.This one rule haunted Livermore because he did not always adhere toit. In fact, he consistently broke it. When he made a large proﬁt in a trade,he did not take some of the proﬁt off the table, out of the market and put itin the bank. It was one of the major regrets of his trading years.Most people do not think they earned the money they make in themarket because all they have done is make a phone call and shufﬂe somepaper. There is no actual work involved in trading, no service being offered such as a doctor, mechanic, carpenter, plumber provides, nothingbeing manufactured like a lawn mower, a car, a suit of clothes. As a result,a lot of people have trouble psychologically, it appears to them as unhealthy money, rolling in rapidly, and stopping for but a short visit. Thespeculator in such instances loses his sense of balance. The uninitiatedpublic investor says: “If I can make 500 percent on my capital in 2 months,think what I will do in the next 2! I will make a fortune with basically nowork. I call, place my order with the broker, and collect my proﬁts—it’s nowonder rich people play the stock market.”Such speculators are never satisﬁed. They continue to shoot theworks until somewhere a cog slips, something happens—something drastic, unforeseen, and devastating. At length comes that ﬁnal margin callfrom the broker, the call that cannot be met, and this type of plunger goesout like a lamp. He may plead with the broker for a little more time, or ifhe is not too unfortunate, he may have saved a nest egg permitting a modest new start.Businessmen opening a shop or a store would not expect to makeover 25 percent on their investment the ﬁrst year. But to people who enterthe speculative ﬁeld 25 percent is nothing. They are looking for 100 percent. And their calculations are faulty; they fail to make trading a businessand run it on business principles. In the end, Livermore believed that the
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only money that is ever taken out of Wall Street by speculators is themoney they draw out of their accounts after closing a successful trade.Livermore used to tell this story to his friends:“I recall one day in Palm Beach. I left New York with a fairly largeshort position open. A few days after my arrival in Palm Beach the markethad a severe break. That was an opportunity to cash paper proﬁts into realmoney—and I did.“After the market closed I gave a message to the telegraph operator totell the New York ofﬁce to send immediately to my bank one million dollars to be deposited to my credit. The telegraph operator almost passedout. After sending the message, he asked if he might keep that slip. I inquired why.“He said: I’ve been an operator here in Palm Beach for twenty yearsand that was the ﬁrst message I ever sent asking a broker to deposit in abank money for the account of a customer.“He went on: I’ve seen thousands and thousands of messages passingover the wire from brokers demanding margins from customers. Butnever before one like yours. I want to show it to the boys.”The only time the average trader can draw money from his brokerageaccount is when he has no position open or when he has an excessive equity. He won’t draw it out when the markets are going against him becausehe needs all his capital for margin.He won’t draw it out after closing a successful deal because he says tohimself: “Next time I’ll make twice as much.”Consequently most speculators rarely see the money. To them, themoney is nothing real, nothing tangible. For years, after a successful dealwas closed, Livermore made it a habit to draw out cash. He would draw itout of the market at the rate of $200,000 or $300,000 a clip. It had a psychological value for Livermore. He made it a policy to count the moneyover again. It was then that he knew he had something in his hand. He feltit. He spent a little. He knew his hard work was producing real money.For Livermore, money in a broker’s account or in a bank account wasnot the same as if you felt it in your own ﬁngers once in a while. Then itmeant something. There is a sense of possession that makes you just a little bit less inclined to take headstrong chances of losing your gains. Soevery trader should have a look at his real money once in a while, particularly between market deals.Livermore was unable to make any money outside of Wall Street. Infact, he lost many millions of dollars, which he took from Wall Street andinvested in other ventures, such as real estate in the Florida boom, oilwells, airplane manufacturing, and the perfecting and marketing of products based on new inventions. He always lost every cent.
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In one of these outside ventures that had whipped up his enthusiasm,he sought to interest a friend of his in investing $50,000. His friend listened to his story very attentively. When Livermore ﬁnished, the friendsaid: “Livermore, you will never make a success in any business outside ofyour own. Now if you want $50,000 with which to speculate it is yours forthe asking. But please trade stocks and stay away from business.” Thenext morning, to his surprise, the mail brought a check for that amount,which Livermore did not need and sent back.The lesson here again is that trading stocks is itself a specialty business like any other, and should be so viewed by all who wish to trade inthe market. Do not permit yourself to be inﬂuenced by excitement, ﬂattery, or temptation. Keep in mind that brokers sometimes innocentlybecome the undoing of many traders. Brokers are in the business tomake commissions. They cannot make commissions unless customerstrade. The more trading, the more commissions. The speculator wantsto trade, and the broker not only is willing, but too often encouragesovertrading. The uninformed trader regards the broker as his friend andis soon overtrading.Now if the speculator were smart enough to know at just which timehe should overtrade, the practice would be justiﬁed. He may know oftimes when he could or should overtrade. But once acquiring the habit,very few traders are smart enough to stop. They are easily carried awayemotionally, and they lose that peculiar sense of balance so essential tosuccess. They never think of the day when they will be wrong. But thatday always arrives. The easy money they might have made takes wing, andanother trader goes broke.Follow the rules—never make any trade unless you know you can doso with ﬁnancial safety.
POSTSCRIPTMany legends about Jesse Livermore have persisted over the years. In myresearch on Livermore, the following story was told to me by Patricia Livermore, his daughter-in-law, married to Jesse Jr., and then again by PaulLivermore, Jesse’s younger son. I have written it down faithfully as it wastold to me.
Livermore’s Annual New Year’s Ritual“Good afternoon, Mr. Livermore.”“Hello, Alfred.”
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It was the Friday before the New Year of 1923. Livermore walked intothe Chase Manhattan Bank, late in the afternoon. He was warmly greetedby Alfred Pierce, the bank manager. Livermore was one of the bank’s bestcustomers, keeping a balance of at least two million dollars in reserve forhis special “stock situations,” when he needed extra cash to establish oneof his famous stock purchases or perhaps engage in a raid or activate acommodity corner.“We have everything ready for you, J.L.,” Alfred said. (People whoknew Livermore well called him J.L.)Livermore looked at his watch—it was almost 5:15. The bank was already closed. They had let him enter the bank through the employees’door. “Yes, J.L., the closing bank vault time-lock is set for 5:30, as always.”They walked in silence across the great vaulted room of the mainbranch through the door that separated the tellers’ cages from the publicand entered the back of the bank.“And Monday morning?” Livermore asked.“Monday, the timer on the vault is set to open at 8:00 sharp, likealways.”“I just like to be sure.” Livermore added with a smile.“I understand, J.L.—by that time you will have had enough solitude.”“Yes Alfred, of that I am sure.” Livermore said. He was carrying aleather briefcase. Alfred looked at the briefcase. “Do you mind me askingwhat’s in the briefcase?”“Not at all. It is my entire trading history for 1923. I will review everytrade I made and refer to my notes. I keep good notes on all my trades thatexplain why I bought or went short and why I closed my positions.”“So you don’t win every time?” Alfred said facetiously.“Alfred, there are many rumors about me; of course, you know that Ilose. I am only human. The idea is to get out fast when a trade goesagainst you. I often lose, that is what I am trying to ﬁgure out this weekend—why did I lose on certain trades over the year.”They approached the main vault. It was huge with a giant solid steeldoor. Two armed security men stood on either side of the door. They nodded at Alfred and Jesse Livermore. They knew what was going on.The two men crossed over the threshold and entered the cavernousvault. There was a large amount of cash in a series of open chests. Most ofthe bills were hundreds with one chest full of twenties and ﬁfties. Therewas a desk, a chair, a cot, and an easy chair in the middle of the cash.There was a special light above the desk and a second light above the easychair. Livermore went over to the cash in the open chests and lookeddown at the uncovered bills. “There is almost ﬁfty million here. The exactamount is written on the pad on your desk. The last of it came over fromE. F. Hutton’s this afternoon.”
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Jesse Livermore had sold out almost every position he had in bothstocks and commodities, as he did at the beginning of every new year. Hestared down at the cash.“I would like to have the commission on just these sales, J.L.,” Alfred said.“This is not all of it. In some cases the market was too thin to take thehit, so that stock will be sold slowly over the next few weeks or so, andwill be sent here for safekeeping.”“When will you resume trading?”“Most likely in February, after I get to Palm Beach.”The red light on the ceiling started to ﬂash and a low-level bell rang at20-second intervals. The bank manager looked at his watch.“Five minutes before the vault closes, J.L. The food is over here.”The bank manager went to an icebox in the corner. “We got everythingthat your ofﬁce manager Harry Dache ordered for you. He actuallybrought the food over himself about an hour ago, and we had an ice delivery around noon. Bread, cold cuts, vegetables, water, milk, juices andthe makings for some old fashioneds.” Alfred pointed into the open icebox door.“Thanks, those old fashioneds will come in handy.”“Right you are, J.L. I’m going to leave now, I suffer from claustrophobia and all this money scares me.”Livermore walked the bank manager to the vault door. They shookhands. “J.L. if anyone ever knew about this . . . well . . . they might thinkthat you were eccentric.”“Eccentric is a kind word, Alfred.” Jesse Livermore smiled as thedoor started to swing shut, pushed by the two armed guards. “You see, Alfred, all year long all I see is and endless stream of paper. This weekendmakes it real for me . . . real cash—nothing like it.Livermore stood at the door as it clanged shut. The lights above thedesk and the easy chair now provided an eerie but adequate light. Livermore surmised that no one had ever actually tested them with the doorshut; no one would volunteer to be locked inside the vault.He turned and walked to the desk surrounded by almost ﬁ