the elements involved with the stock market, and remember that the key to success in the stock market is knowledge andpatience. So few people succeed in the market, because they have no patience and are generally ignorant of the market. Finally, they want to getrich quickly.Anyone who ﬁgures that his success is dependent upon chance mayas well stay out of the market. His attitude is wrong from the very start.The great trouble with the average persons who buys securities is thatthey think the market is a gambling proposition.One should realize at the outset that to work in the stock market requires the same study and preparation as law or medicine. Certain rules ofthe stock market are to be studied as closely as if you were a law studentpreparing for the bar. Many people attributed Livermore’s success to luck.As Livermore said, “That is not true; the fact is that since I was 15, I havestudied this subject closely. I have given my life to it, concentrating uponit and putting into it my very best.”
SUMMARY OF LIVERMORE ADVICE• Keep your own counsel;• Maintain silence on matters concerning the stock market;• Do not listen to or take tips.If Jesse Livermore were still alive, he would advise the current traders oftoday: If you want to watch FNN or MSNBC or Bloomberg, then do sowith the volume in the mute position.It was Jesse Livermore’s belief that you should never listen to a topcompany executive talk about his company. He is simply acting like acheerleader. In order to keep his share price high or at least where it is currently trading, the corporate executive is often compelled to shade thetruth. He believed that top executives often simply tell lies about theircompany’s situation. The same may be true of the “impartial” analysts whosecretly may hold stock or they may be ordered to give a favorable reportby the company they work for. A trader can be duped by these sources.The entire subject of the media is an area that can throw the trader offbalance, since the media and their guests can present ﬁnancial material
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any way they want. But it does not matter what people say. What matters iswhat the market says. Let’s take an example: The head of the Federal Reserve Bank makes a statement at a speech given at a college one eveningand the press picks up a few sentences out of the speech like “It is my desire that the country not enter a trade war with the European CommonMarket,” and it comes out in headlines: “Greenspan Says We Are About toBe Engaged in a Trade War with the European Common Market—ExpectNew Embargoes and High Tariffs on American Goods Going to Europe.”The next day the market takes a severe drop at the beginning of trading. The smart trader will wait and stay calm because he knows this willpass and the market will most likely absorb the news and recover back towhere it was. The answer lies in the action of the market—not what people say about things.This of course, is a complicated issue since with sudden real newssuch as a war or a natural disaster, those items may affect the market on areal basis. And don’t misunderstand please—Livermore kept up with current events. He rose at six every morning and read the morning paperscover to cover. He also had phones that were directly connected to the exchanges in Paris, London, Chicago, and New York, and talked often to thetraders on the ﬂoor.He was also a person who went broke several times from taking tips.Often, the tips will be given to you with the best of intentions. They maycome from friends, even relatives, so they will sound very appealing. Theymay even emanate from insiders in a company (ofﬁcers and directors) thathave perhaps created a new technology or a revolutionary product and youmay be told that the company is about to announce the breakthrough.Such a tip, also is dangerous because it may really come true, and the stockpops upward. Then the trader is remorseful that he did not act on the tip. . . so he may take the next tip he gets. It was Livermore’s life experiencethat these tips rarely paid off, and in the long term, they often cost him a lotof money. His ﬁnal rule—take no tips—not ever . . . period.
CHAPTER 8
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very stock is like a human being: It has a personality—a distinctivepersonality—aggressive, reserved, hyper, high-strung, volatile, boring, direct, logical, predictable, unpredictable. Livermore often studied stocks as you would study people, after a while their reactions tocertain circumstance become more predictable.Livermore was not the ﬁrst to observe this. There are traders whohave made a lot of money in the stock market by just analyzing the personality of a stock and following that personality, reacting to it by buying andselling it according to its personality traits. But beware—not often, butsometimes, personalities change.Livermore ﬁrmly believed that as long as a stock was acting properly—progressing, with normal reactions such as consolidations, corrections,and proceeding in the direction of the trend—there was nothing to fear, noreason for a speculator to concern himself. And the fact that a stock is selling in new high territory should only encourage the speculator.On the other hand, a speculator must never become complacent orrelaxed to the point that he misses the clues that the stock has toppedout and is creating a Pivotal Point that will set it off in a new direction,perhaps a reversal in trend. The lesson: Be ever-vigilant, alert, for thedanger signs.The essentials to stock market success are knowledge and patience.Few people succeed in the market, mostly because they have no patience.They have a strong desire to get rich quickly. They buy mostly when astock is going up and is near the top. They are not willing to buy when the127
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stock goes down and wait until it forms a pivotal point and begins to recover—if it does recover.In the long run, patience counts more than any other single elementexcept knowledge. The two really go hand in hand. Those who wantto succeed through their investments should learn that simple truth.You must also investigate before you buy; then you are sure your position is sound.Never become discouraged by the fact that your securities are movingslowly. Good securities in time appreciate sufﬁciently to make it wellworthwhile to have patience.The only time to buy is when you know a stock will go up. These situations come along only rarely—the trader must wait, be patient; sooner orlater the right situation will come along.In trading to beat the game, a big part is the right timing. Livermore’squest was never ending: to reﬁne and develop the Pivotal Point approach,his approach to trading new highs, ﬁnding the industry leaders and thebest industry group. These stock-trading theories were all developed aftermuch experience and effort. But it was the mental challenge that was always his passion and challenge.But like all traders, he also enjoyed what the money could do.
WHEN DOES A STOCK ACT RIGHT?Markets never stand still. They are very dull at times, but they are not resting at one price. They are either moving up or down, if only a fraction.When a stock gets into a deﬁnite trend, it works automatically andconsistently along certain lines throughout the progress of its move.At the beginning of the move, you will notice a very large volumeof sales with gradually advancing prices for a few days. Then what Livermore termed a Normal Reaction will occur. On that reaction, thesales volume will be much less than on the previous days of its advance.That little reaction is only normal. Never be afraid of the normal movement. But be very fearful of abnormal movements, like a major changein personality.In a day or two, activity will start again, and the volume will increase.If it is a real movement, in a short space of time the natural, normal reaction will have been recovered, and the stock will be selling in new highterritory. That movement should continue strong for a few days with onlyminor daily reactions.Sooner or later, it will reach a point where it is due for another normalreaction. When it occurs, it should be along the same lines as the ﬁrst re-
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action, because that is the natural way any stock will act when it is in adeﬁnite trend.At the ﬁrst part of a movement of this kind, the distance above the previous high point to the next high point is not very great. But as time goeson, you will notice that it is making much faster headway on the upside.Take a stock that starts at 50. On the ﬁrst leg of the movement, itmight gradually sell up to 54. A day or two of normal reaction might carryit back to 52. Three days later, it is on its way again. In that time it mightgo up to 59 or 60 before the normal reaction would occur.But instead of reacting, say, only a point or a point and one-half, a natural reaction from that level could easily be 3 points. When it resumes itsadvance again in a few days, you will notice that the volume of sales atthat time is not nearly as large as it was at the beginning of the move—thestock is becoming harder to buy.That being the case, the next points in the movement should be muchmore rapid than before. The stock could easily go from the previous highof 60 to 68 or 70 without encountering a natural reaction.When that normal reaction does occur, it could be more severe. Itcould easily react down to 65 and still have only a normal decline. But assuming that the reaction was ﬁve points or thereabouts, it should not bemany days before the advance would be resumed, and the stock should beselling at a brand new high price. And that is where the Livermore time element comes into play. Don’t let the stock go stale on you. After attaininga good proﬁt, you must have patience, but don’t let patience create aframe of mind that ignores the danger signals. Always be on the alert.Don’t be lulled into complacency.A danger signal: The stock starts up again, and it has a rise of six orseven points in one day, followed the next day by perhaps eight to tenpoints—with great activity—but during the last hour of the day all of asudden it has an abnormal break of seven or eight points. The next morning, it extends its reaction another point or so, and then once more startsto advance, closing very strong. But the following day, for some reason, itdoes not carry through.This is an immediate danger signal.All during the progress of the move, it had nothing but natural andnormal reactions. Then all of a sudden an abnormal reaction occurs—andby abnormal I mean a reaction in one day of six or more points from anextreme price made in that same day —something it has not had before.When something happens abnormally in the stock’s normal pattern, it isﬂashing you a danger signal that must not be ignored.You have had patience to stay with the stock all during its naturalprogress. Now have the courage and good sense to honor the danger signal and step aside.
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This is not to say that these danger signals are always correct because,as stated before, no rules applying to stock ﬂuctuations are 100 percentright. But if you pay attention to them consistently, in the long run you willproﬁt immensely.A speculator of great genius once told Livermore: “When I see a danger signal handed to me, I don’t argue with it. I get out! A few days later, ifeverything looks all right, I can always go back in again. Thereby I havesaved myself a lot of worry and money. I ﬁgure it out this way. If I werewalking along a railroad track and saw an express train coming at mesixty miles an hour, I would be a damned fool not to get off the track andlet the train go by. After it had passed, I could always get back on the trackagain, if I desired.”Every judicious speculator must always be on the alert for dangersignals.Curiously, the trouble with most speculators is that something insideof them keeps them from mustering enough courage to close out theircommitment when they should. They hesitate, and during that period ofhesitation they watch the market go many points against them. Then theysay: “On the next rally I’ll get out!” When the next rally comes, as it willeventually, they forget what they intended to do, because in their opinionthe market is acting ﬁne again. However, that rally was only a temporaryswing that soon plays out, and then the market starts to go down inearnest. And they are still in it—due to their hesitation. If they had beenusing a guide, it would have told them what to do; not only saving them alot of money but eliminating their worries.As mentioned, emotion is the greatest enemy of the average investoror speculator. Why shouldn’t a stock rally after it starts down from a bigadvance? Of course it will rally from some level, if the stock is basically allright ﬁnancially. But why hope it is going to rally at just the time you wantit to rally? Chances are it won’t, and if it does, the vacillating type of speculator may not take advantage of it.Banish wishful thinking. A trader cannot be successful by speculating every day or every week. There are only a few times a year, possiblyfour or ﬁve, when you should allow yourself to make any real commitment at all. In the interims, you are letting the market shape itself forthe next big movement. If you have timed the movement correctly, yourﬁrst commitment will show you a proﬁt at the start. From then on, allthat is required of you is to be alert, watching for the appearance of thedanger signal to tell you to step aside and convert paper proﬁts into realmoney.Remember this: When you are doing nothing, those speculators whofeel they must trade day in and day out are laying the foundation for yournext venture. You will reap beneﬁts from their mistakes.
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Speculation is far too exciting for most people; most people whospeculate hound the brokerage ofﬁces or receive frequent telephone calls,and after the business day they talk stock market with friends at all gatherings. Trading is always on their minds. They are so engrossed with theminor ups and downs that they miss the big movements.Almost invariably, the vast majority have commitments on the wrongside of the market when the broad trend swings get under way. The speculator who insists on trying to proﬁt from daily minor movements may missthe next important change when it occurs.
TIME—THE FOURTH DIMENSION IN TRADINGLivermore heard a story that had a great effect on him about a remarkably successful speculator who lived in the California mountains and received quotations three days old. Two or three times a year, he would callon his San Francisco broker and begin writing out orders to buy or sell,depending upon his market position. A friend of Livermore’s, who spenttime in the broker’s ofﬁce, became curious and made inquiries. His astonishment mounted when he learned of the man’s extreme detachmentfrom market facilities, his rare visits, and, on occasion, his tremendousvolume of trades.Finally, he was introduced to the trader from the mountains, and inthe course of conversation inquired of this man from the mountains howhe could keep track of the stock market at such an isolated distance.“Well,” the man replied, “I make speculation a business. I would be afailure if I were in the confusion of things and let myself be distracted byminor changes. I like to be away where I can think. You see, I keep arecord of what has happened, after it has happened, and it gives me arather clear picture of what markets are doing.“Real movements do not end the day they start. It takes time to complete the end of a genuine movement. By being up in the mountains I amin a position to give these movements all the time they need. But a daycomes when I get some prices out of the paper and put them down in myrecords. I notice the prices I record are not conforming to the same pattern of movements that has been apparent for some time.“Right then I make up my mind. I go to town and get busy!”Consistently, the man from the mountains, over a long period of time,drew funds in large quantities from the stock market. He was somethingof an inspiration to Livermore. After hearing this story, Livermore went towork harder than ever trying to blend the element of time with all theother data he had compiled. By constant effort, he was able to bring his
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records into a coordination that aided him to a surprising degree in anticipating coming movements.The dimension of time (not timing) was the last element that fascinated Jesse Livermore. He was studying it in detail at the time of his deathHe believed that in the stock market, time is not money—time is time—and money is money.
THE MARKET OPERATES IN FUTURE TIMEEvery successful trader must understand that the market does not operatein present time; it operates in future time. The current market of 2004 bottomed out in October of 2002, forming a clear Reversal Pivotal Point. (SeeFigure 8.1.) This went basically unnoticed by most traders, mutual funds,and media pundits. Livermore would have loved it!Behind all major movements in the stock market are irresistible forcesat work. This is all the successful speculator needs to know. Just be aware
Figure 8.1 The Nasdaq shows two Reversal Pivotal Points 1997–2004.
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of the actual stock movements, and act upon that knowledge. It is too difﬁcult to match up world events or current events or economic events, withstock market movements. This is true because the stock market alwaysmoves ahead of world events. The stock market is not operating in the present or reﬂecting the present; it is operating on what is yet to be, the future.The market often moves contrary to apparent common sense and worldevents, as if it had a mind of its own, designed to fool most people, most ofthe time. Eventually, the truth of why it moved as it did will emerge.It is foolish to try and anticipate the movement of the market basedon current economic news and current events, such as the balance of payments, Consumer Price Index, and the unemployment ﬁgures, even the rumor of war, because these are usually already factored into the market.Livermore did not ignore these facts or remain ignorant of them—he wasn’t. But these were not facts he could ever use to predict the market. Afterthe market moved, it would be rationalized in endless post mortems bythe ﬁnancial pundits, and later when the dust had settled, the real economic, political, and world events would eventually be brought into focusby historians as to the actual reasons why the market acted as it had. Butby that time it was too late to make any money.Trying to ﬁgure out the why of a market move can often cause greatemotional strife. The simple fact is, the market always precedes economicnews; it does not usually react to economic news for any sustained period.It must be understood by the astute trader that the market lives and operates in future time. For example, a good earning statement is issued by acompany and the stock proceeds to fall in price—why? Because the market had already factored in those earnings.
TIME AS A TRADING DIMENSIONLater in Livermore’s trading history, he decided that he would not holdstocks for long that did not move in the direction he had anticipated. If hehad followed his rules and waited for what he considered to be the perfecttime to buy the stock, and if it did not move as he believed it should movewithin a few days or what he considered a reasonable time, he would thensell out the position. He would wait days, weeks, months, for the stock toposition itself at the spot he thought most opportune, in other words theperfect moment to make his purchase—when every factor was in his favor. If the stock did not do as expected, he would often sell out his entireposition, even if the stock did not decline.Why? Because the successful trader must try and keep his money circulating as a merchant must keep his inventory moving, so he can keep
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the inventory fresh. The one thing he had learned in his many years ofplaying the stock market was that there are always opportunities in themarket, so to remain with your cash in a stand-by position meant thatyour money, your inventory, was inactive now, but this could yield hugebeneﬁts in the future, when it was ﬁnally committed to that special situation. Just as it is true that many people will sell their good stocks and keeptheir losers it is true that they will also keep the stocks that are ﬂat, notdoing anything or going anywhere.Please be aware that this does not mean a stock will not have a normal correction or a normal consolidation in an upward trend. What we aretalking about here is a stock that is just wallowing in a trading channel,making no progress in either direction. It must be determined whether thestock is being accumulated or is being distributed. If it is not clear, then itis sometimes best to exit the stock than to take a chance that it is beingdistributed and will eventually move against you and go down and costyou money. Give the stock a little time to show itself in these situations,but waste no time in closing out an inconclusive stock and moving on toanother trading situation.Livermore often sold a stock that had even moved a point or two inhis favor, but he simply did not like the weak or limp manner in which itwas acting. It did not matter to him—even if he had a small proﬁt or asmall loss—the major fact remained the stock did not do what he had analyzed and believed that it would do. So the conclusion was obvious and always simple to him—his judgment had been wrong and therefore he mustexit the trade.One thing he knew for sure was that his judgment had been wrong inthe past and that it would be wrong again in the future. The danger was innot recognizing his mistakes and getting out in time. The old adage is correct—pride often does come before a fall.The worse kinds of stocks are what he called Listless Drifters.These are stocks that do not move in the desired manner and simply tieup a stock market trader’s capital as they hang out there drifting in noman’s land. Whenever Livermore was forced to depend on hope, he always felt exposed to danger. When he simply took his loss, he knewwhat it was, and he know what he would have to make back to get intoproﬁt. Also, if he stayed with the losing or listless position, it had a negative psychological effect and always bothered him as he moved aheadwith future trades.Livermore discovered that he could not afford to trade in anything butlive stocks, stocks that are leading the pack, stocks that have inherent energy. This energy, or momentum, always meant trading on both sides ofthe market—the upside and the downside, long or short.
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He observed many, many people who purchased stocks and put themaway in safe deposit boxes or safes, feeling that their investments weresafe. These were the thoughts that people had for the stocks of steel, radio, aircraft, oil, railroads, and hundreds of other safe-as-money-in-thebank securities that all eventually went sour in his day. This was nevertrue in Livermore’s view: One can never assume that a stock can bebought and put away for the future.It was essential for Livermore to keep his capital in circulation. Remember, when a merchant has part of his capital frozen out of circulationhe must then make all his proﬁt on the capital that is left. This hampersand hinders him because that unfrozen capital must often work twice ashard to make up for the dead, frozen capital, which yields little or nothing.It must also be understood by the trader that in the Livermore TradingSystem, money sitting in cash was not deemed to be capital out of circulation. It was considered reserve capital waiting to be used at the propitiousmoment when it could bring in huge returns, as it often did for Livermore.But above and beyond this reasoning are what he called lost opportunities. Because their capital is frozen, these stock traders miss manygolden opportunities to trade the winners, the stocks that would havebought them proﬁts and success—proﬁts that were unavailable becausetheir capital was tied up in stagnant, unproﬁtable situations.Hope is the villain here, and it has ruined millions of traders over thecourse of time—take your losses right away; after all, they are realwhether you sell the stocks or not.As a result of this thinking about the dimension of time, Livermoreinitiated a new technique into his trading system near the end of his life,a technique that is still revolutionary in its thinking, even in today’sstock market.Livermore used two stops when he entered a trade, a price stop and atime stop. These were combined with his thinking that he would not staywith any trade more than a few points if it moved against him, and hewould not stay with a stock position for more than a few days if the stockdid not perform as he expected.This became the lifeblood of his trading system because it was howhe kept his capital in working circulation. It may sound contradictory, butit isn’t; there are times when he was out of the market completely with allhis working capital in cash, waiting and waiting for the market to choose atrend and for the perfect trading scenario to re-present itself to him.“Often money that is sitting can later be moved into the right situationat the right time and make you a vast fortune. Patience, Patience, Patienceis the key to success, not speed; time is a cunning speculator’s best friend,if he uses it correctly.
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“Remember the clever speculator is always patient and has a reserveof cash.”—Jesse LivermoreThe concept of time will be even more challenging in the comingdecades as worldwide stock markets become digitalized and trade electronically (with no human help). The Toronto Stock Exchange and theGerman Dax have already converted to electronic markets that operatewith no hands-on help from human beings. This will eventually result inworldwide 24-hour-a-day trading. One of the unpredictable aspects, however, is that a person could go to sleep and awake in the morning withdeep losses or healthy proﬁts.Please note, the concept of global trading—or trading following therising sun, beginning in Japan and ending in the United States—is a realitythat is not far away from common usage. It is actually possible to do thisnow, and it is being done currently by a handful of ambitious traders, whooften go without sleep.Livermore used a week as his rough time frame in deciding whetherhe would hold a stock that he had purchased and that did not act as hepredicted. In other words, he would give a stock ﬁve trading days to moveafter he had acquired it.As already stated, his reasoning was simple: “I have waited untilwhat I believe is the perfect moment to pull the trigger on a stock, andgo ahead and buy a stock or sell it short. If the stock does not perform,then something is wrong with my judgment, because I thought everything was ready when I pulled the trigger . . . it is obvious if the stockdoes not do as I anticipated, then I have not analyzed the situation correctly . . . therefore I must cancel out the trade and not wait for the stockto act right. As in all similar cases, the solution will be revealed to me ata later date.”What was novel and important here is that: The stock did not haveto move against Livermore for him to sell it. The stock could remainﬂat or near the price he purchased it. It could simply lie languishing.The point to Livermore was that whatever it is doing, it is not doingwhat he had expected it to do, so his safest bet was to get out of thetrade and move on or perhaps go back into the situation after the movehad been conﬁrmed.This is a far more difﬁcult concept to execute than may appear to theaverage trader. Emotionally, it becomes a struggle, since the trader maynot have lost any money in the trade. It may be recalled that Livermorealso said a trader needs a reason to buy a stock and a reason to sell. Thistechnique provides the reason: The stock did not do what it was supposedto when it was bought! This was a good enough reason for Livermore to
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close out the trade. This is an essential factor in the Livermore Stock Trading System.One of the main challenges for a trader is to identify the currentleaders and to spot the new leaders who are waiting to take over fromthe current ones. During major shifts and changes in market direction,it is of paramount importance to observe the leaders that are being driven out and identify the new stocks that will assume the leadership inthe future.It is usually 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. In the long run, this will pay off.Livermore’s theories and methods came from his never-endingstudy of the market. He believed a trader is always a student of themarket, never a master. Like a ship’s captain who studies the oceans,the tides, the moon, his fellow shipmates, the construction of his ship,and the stars for navigation, he knows he can never be in completecontrol, for a variety of reasons. He knows the biggest reason is thathe cannot control the weather, the weather is in the hands of God andnature.Livermore knew that the market is comprised of human beings, andhuman beings are mostly driven by emotion not logic. He knew that people were often unpredictable and not like the stars in the heavens with areliable pattern or the tides that rise and fall as predicted. With humans,nothing in their behavior is certain except uncertainty. A good stocktrader must, in the end, be a student of human behavior, but he can improve his odds by placing the highest probabilities on his side. In Livermore’s case, he made several fortunes by doing this correctly. In everycase, his theories were based on actual trading experience. His thinkingwas way ahead of its time, and even today much of his thinking revolutionary and inspiring. His vision of the dimension of time and how it applies to trading stock is one of those factors.
The Time StopAnd please add to your trading arsenal what Livermore stated before: “Ialways have two stops in mind when I enter a trade: I have a price stopand I have a time stop. I will not stay with any trade more than a fewpoints if it moves against me and I will not stay with a stock position formore than a few days or perhaps up to a week, if the stock does not perform as I expect it to perform. And there is still much more for traders todo on the subject of time in the future, as technology and the humanknowledge base continues to expand.”
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HISTORY REPEATING ITSELFLivermore believed that the game of speculation is the most uniformly fascinating game in the world. But it is not a game for the stupid, the mentally lazy, or the person of inferior emotional balance, or for theget-rich-quick adventurer. They will die poor.Over a long period of years, he rarely attended a dinner party including strangers when someone did not sit down beside him and inquire afterthe usual pleasantries:“How can I make some money in the market?”In his younger days, he went to considerable pains to explain all thedifﬁculties faced by the trader who simply wishes to take quick and easymoney out of the market; or through courteous evasiveness, he wouldwork his way out of the snare.In later years, his answer became a blunt “I don’t know.”It was difﬁcult for him to exercise patience with such people. In theﬁrst place, the inquiry is not a compliment to a man like Jesse Livermorewho has made a scientiﬁc study of investment and trading.It would be similar for the layman to ask an attorney or a surgeon:“How can I make some quick money in law or surgery?”It is simply hard work, constant study, discipline, and unyielding perseverance that leads the way to success in the stock market, as it does inany profession. But before we go further, let me warn you that the fruits ofyour success will be in direct ratio to the honesty and sincerity of yourown effort in keeping your own records, doing your own thinking, andreaching your own conclusions.You cannot read a book on how to keep ﬁt and leave the physical exercises to someone else. Nor can you delegate to another the task of keeping your records. You must understand and follow faithfully Livermore’sstock trading system, and understand and combine all the aspects of Timing, Money Management, and Emotional Control, as set forth in thesepages. Livermore could only lead the way, and he would be a happy man ifthrough his guidance, a trader would be able to take more money out ofthe stock market than he put in.This information is for that portion of the public that at times may bespeculatively inclined. Some points and ideas are presented here thatcome directly from Livermore’s many years as an investor and speculator.Anyone who is inclined to speculate should look at speculation as a business and