Blog Post

Yesterday I began outlining some of the principles Jesse Livermore used so successfully to make $1million during the Panic of 1907. $1million doesn’t sound like a lot these days, but of course it must have been worth closer to $100million in today’s terms. Please keep in mind that there are probably a thousand other lessons that one can glean from Livermore’s trading career, and many of his mistakes and shortcomings are probably more instructive.

4.      Probe out weak points. As noted previously, Livermore believed the overall market had the greatest influence on prices. But this didn’t stop him from identifying weaker stocks to short in a bear market, or stronger stocks to go long of in a bull market. Livermore was clearly a believer in relative strength – although his vanity led him to violate this principle on occasions. He looked for unexplained weakness in a stock’s price in the belief that a weak stock would fall further during a general decline.

The main point here is to let price action be your guide. Livermore would sell the general list and let the subsequent price action tell him which stocks acted weaker and should be held for the longer term, and which stocks should be discarded. I suggest it’s tempting fate to short unusually strong stocks, or, conversely, to buy unusually weak stocks. There may be a very good and unpublished reason for the price action. However, don’t use relative strength naively. The odds are much better if you buy/sell as close to a base/top as possible. Entering late in a trend is just asking for trouble. It’s better to follow the crowd at the start of a trend, and better to be a contrarian when the trend is about to end. The trick is in knowing when to do what.

(As an aside, how dodgy was that bounce in Lehman Bros!? I wouldn’t be surprised to find insiders are dumping their stock after that neat piece of manipulation. The gall of Kerrie Cohen to blame short sellers for a 10% decline after LEH cooked the books to pump their stock!)

5.      Don’t listen to wall street chatter. Livermore railed against those that loved to give and receive tips. In his opinion traders who engaged in tips were ‘like drunkards’, their “hope bandaged by [their] unwillingness to do any thinking”. Similarly, he distrusted the financial press, understanding full well how easily it could be manipulated. Finally, he was usually fiercely independent of his peers (with a couple exceptions, such as cotton trader, Percy Thomas). Full timers are just as susceptible to rumor mongering as amateurs.

Nicholas Darvas also pointed out the dangers of listening to the opinions of others. Better to develop your own system, thoroughly back test and understand it, and study your tradecraft until you know enough to see through the BS that others are constantly peddling. I’m constantly amazed by the delusional market commentary I read in some newsletters. A professional investor here in Oz was embarrassed by several bad calls he made last year, and, having suffered significant losses as our market crashed, he’s now exacerbated his foolishness by calling the market bottom. A brave call given that our average bear markets last 370 days, and this one is only147 days old so far. As Livermore says about the 1907 bear,

“It was curious how, after suffering tremendous losses from a break of fifteen or twenty points, people who were still hanging on welcomed a three-point rally and were certain the bottom had been reached and complete recovery begun.”

Of course it’s fine to have a theory about when and why the market should stabilize. But I’ve noticed already how many ‘market experts’ are calling an end to the bear market, more out of hope than for any other reason. They may be right. But a trusty coin is usually a more reliable tipster. Better to do your own thinking and research, and constantly look for evidence that you’re wrong.

For what it’s worth (not much as I’ve outlined above), my moistened finger in the wind call is that we’re in for further falls. I believe we’re in a bear market, and bear markets have typically declined by at least 30% and lasted for at least nine months. This one could be a lot worse for the reasons outlined by Roubini and Jim Grant. Check out Grant especially.

In any case, I’m likely to remain bearish until the Coppock (plotted in green below) crosses below zero and then turns up. This has been a very reliable – although late – indicator for the S&P500 for determining the start of a bull market. Since 1960, there’s been only one false signal (circled in red).