Some Lessons From Jesse Livermore

Almost all good traders have heard of Jesse Livermore (or at least should have) and many may have even read ‘Reminiscence of a stock market operator’. For traders that is a must read book and every now and then I pick it up to read it yet another time. And, I always, always, find some new learning from Jesse Livermore. Even after 40 years of being at this work.

So it was, during this weekend when I picked up the book for a round of riffling thru it. And I came up with this one: Obviously the thing to do was to be bullish in a bull market and bearish in a bear market. Now, one may wonder as to what is so significant about this line? It actually seems pretty silly, coming from one of the Wall Street greats! I probably read thru the line many times, just passing over it. When I read it this time, somehow, it struck me differently. Perhaps it is the trading experience of the recent times that set it apart.

Market has been range bound now for the past three months or so. Hence, essentially, it is neither bullish nor bearish. But we carry images of the trend in our minds all the time. For someone who has been trading the bull markets of 2016-17 successfully, the bullish fever may not yet have died down. For another, who has been trading successfully the bear market of 2018 (into early 2019) the mind may be dominated by bearishness. Ultimately we trade our bias and beliefs about the trends and the market. The former will still be looking to buy during dips and quite unable to short aggressively while the latter would be doing the reverse- shorting most of the time and seldom being able to buy the forays into support zones from where bounces occur. Depending on how well they do this, success will ensue.

But what Jesse Livermore is really talking about here is timing. And, he is talking about two types of timing here. The first one is Contextual Timing and the second can be termed as Directional Timing. A bull or bear market is a Context in which price action occurs. In 2016-17, no matter what mistakes you made in buying, the market always managed to forgive you and still delivered you profits. But you continued to make the same mistakes in timing during 2018 but the Context had changed. The background now had turned bearish and the cycles were therefore favoring dips rather than rallies. Almost every trader (except the more professional ones, the more disciplined ones) ends up transacting late after the signal. They are all waiting for some form of confirmation or the other before acting. In bear phases, when those sharp rallies are short and limited in time, such late reactions almost always end up near the outer bounds of the rally. The past experience of holding on to a long (created by bullish experiences of 2016-17) prevents quick liquidation as the trade probabilities go awry. Hopes of resumption are harbored until a point (when lots of damage has happened) where it become apparent that it is not going to happen. They cut and book and large loss.

As long as one cannot shake off the effect of the former bull market, this behavior will repeat. In the meanwhile, the trader does keep seeing his friends and neighbors trade short in the current market and they keep making money. The strong downward trend is massaging their trading errors enough to keep giving them profits on their shorts, just like the market did with the bulls a year earlier.

Somewhere along the way ahead, the market will change contexts once again. Typically, this happens more at the macro level but few traders are paying attention to the way the macro affects the micro trends. As a result, they almost always end up missing the shift.

A good practitioner of Technical analysis can probably catch the shift if he is astute in applying the principles of TA that can be found in Directional Timing. This mainly deals with Price action in terms different time frames that are constantly and simultaneously playing out. Meaning, the market is, at the same time, in a scalping cycle or a punting cycle or a swing trading cycle or a momentum investing cycle! We need to have a good grasp of price action tools (candles, line studies, averages, patterns etc) to know the relevant time cycle that we play in. It is the interplay of these different time cycles that induce the market noise. TA tools exist to reduce or clarify the market noise. Every time cycle has its own factors. Today’s order flows will determine today’s ebb and flow; the closing and the news flow determines the trends over the following day or so; clean breakouts with volume and momentum kicking in will determine a swing trading cycle etc. As a trader, you are always fighting multiple time frame influences. It requires long experience as a trader before one is able to discern which time frame to focus on and which one not to. TA tools are just a means to survive long enough to get that experience under your belt.

The amazing thing about trading – and one that keeps it so fascinating and interesting all thru- is that all these considerations about the Context and Direction and cycles and the interplay of different forces have all to be internalized within seconds and we have to react to place a trade. It is when you can get these done as a matter of a process that you can begin succeeding on a consistent basis. It is when you can make out these differences between context and direction that you will finally realise what Jesse Livermore meant by making that seemingly self-evident statement! Focus on the time cycle that is relevant to you (bull or bear) and that creates the context for you. Then use your price action skills to determine the directional moves that you need to pick that are in consonance with your context. You will be amazed to see that even in a bearish trend, there are bullish phases that can give you profits on longs and vice versa. What is necessary is for you to separate the signals from the noise. Those that make no attempts to create this differentiation will keep on losing.

The book is so full of such disarmingly simple gems that one can keep re-reading this classic many times over many years. This is probably my 10th or 15th read of the book but every time you will pick up a new meaning of a statement made by this master of trading. It is a must-read for everyone who wants to succeed at trading and investing. As Jesse Livermore is a great trader