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Five Key Trading Principles From The Great Bear

01/10/13 08:30:18 AM
by Billy Williams

Considered to be the greatest trader who ever lived, Jesse Livermore and his trading career offers five key trading principles to help guide your success.

Security:   AAPL
Position:   Hold

In his heyday, at the beginning of each year, the Great Bear of Wall Street, Jesse Livermore (Figure 1), would sell off any stocks or futures that he was holding, and approach the president of the bank that he would do business with and explain what he wanted to do. After coming to terms, Livermore would lock himself in a vault over the weekend at the beginning of each new year with as much as $50 million in cash in order to review his previous trading year, according to Richard Smitten, a writer and biographer of Jesse Livermore's life and trading career.

According to Smitten, Livermore was a consummate professional who constantly worked at sharpening his trading skills and mental/emotional makeup by isolating himself to study his records of the previous trading year. So focused was his study, Livermore eventually made millions of dollars trading the markets and is considered by many to be the greatest trader to have ever speculated on the stock and futures markets.

A keen observer of human behavior and how it translated into price action in the stock market, he came from humble beginnings in rural New England and later became one of the great stock operators of his time. Early on, without realizing, he modeled the successful personality traits and actions of traders in the bucket shops and Wall Street in the early 1900s.

At the height of his success, he successfully timed the market reversal of the Great Crash of 1929 -- where the stock market plummeted and ushered in the Great Depression -- and made a single-day profit of over $100 million, the equivalent of almost $13 billion in today's money!

As 2013 begins, Livermore's trading career offers key trading principles to reflect on, and integrate into your trading in the new year.

FIGURE 1: THE GREAT BEAR OF WALL STREET. Jesse Livermore made a single day profit of over $100,000,000, or almost $13 billion in today's money, by timing the Great Crash of 1929 when he shorted the stock market, earning him the name "The Great Bear of Wall Street."
Graphic provided by: Creative Commons.
Principle 1: Never Cease To Study Your Craft

Livermore might have been a laborer and farmer like his father if not for his keen sense of observation, where he studied the successful habits of other traders along with keeping copious notes on his results. This was why after having amassed a massive fortune, he continued to lock himself up in a vault with millions of dollars to study his performance along with the biggest winning trades as well as his losing trades.

The money in the vault served to focus his mind on what the end result was that he was seeking as he meticulously reviewed his trades to find the winning elements and refine them further.

This never-ending study is a habit that you should seek to develop to keep you on path of mastery and progress.

FIGURE 2: AAPL. Livermore's trading method centered around trading the strongest stocks in bull markets, then sitting tight. Apple Inc. was exactly the kind of stock that Livermore would look for as it was building strength in a contracted price range in early 2012.
Graphic provided by:
Principle 2: Get Control Of Your Emotions

"Remember this: When you are doing nothing, those speculators who feel they must trade day in and day out are laying the foundation of your next venture. You will reap benefits from their mistakes," said Livermore, on the ability for us to control our emotions.

During Livermore's career, he observed that most speculators did the exact wrong thing at the wrong time and acted that way because they were swept up in the manic behavior of the herd of traders on Wall Street. He reasoned that if he maintained his cool, he would profit by doing exactly the opposite of what the trading herd did at key moments in the market. (See Figure 2.)

When investors and traders were bullish, he was looking to short. When investors and traders were bearish, he would look for opportunities to go long. This pattern played out over and over again where the majority of investors/traders set the condition for him to look to trade the other way.

In trading, you may have a system to trade successfully but you can never be successful without controlling your emotions because you won't be able to prevent your emotions from governing your decisions and override your system every time. (See Figure 3.)

FIGURE 3: AAPL. Livermore's approach would have made him enter as Apple started trending higher and dictated for him to sit tight to get the meat of the bull run before exiting as the stock began to sell off.
Graphic provided by:
Principle 3: Price Is Everything To The Trader

Jesse Livermore believed that everything in the market was reflected in price. It's hard to think of a time where computer monitors and price charts were not readily available, but in Livermore's time, all you had was the ticker tape.

He studied the fluctuations in price, and based on that movement, used that as the basis of his investment decisions. No indicators, no chart patterns, no mechanical buy or sell signals, just price. Price reflects the movement of an underlying instrument in real time and requires an active and alert mind to make effective trades, not rely on high-priced indicators.

It could be argued that indicators just act as stimulus/response mechanisms that cause an overreliance on them in place of real trading decisions based on objective data, especially considering Livermore's mastery of trading, despite not having the technology of the modern market.

Whatever the case, study price and make that the foundation to your trading approach and use that to make your the bulk of your decisions.

Principle 4: Have A System That Matches Your Personality

George Soros and Warren Buffett are two of the world's greatest hedge fund managers, yet they have entirely different approaches to the market, yet are massively successful. Why?

Because each has his own unique trading system that forms the basis of his decisions because it matches his temperament and personality. Could Buffett be as effective as Soros if he adopted Soros' trading approach? Vice versa? Probably not.

When trading any market, be sure to find an approach or system that matches your unique set of skills, personality, and objectives. Once you can marry those two -- trading system/approach to personality -- then you have a license to print money.

Principle 5: Always Control Your Risk

"It is foolhardy to make a second trade if your first trade shows you a loss. Never average losses. Let this thought be written indelibly upon your mind," Livermore is quoted, concerning risk control and taking losses. If you take a 50% loss in the market, it will take a 100% return to get you back to breakeven.

Can it be done? Of course, but it is a massive brain-drain, not to mention incredibly emotionally draining. Besides, just because it can be done doesn't mean that it should be. As a trader, you can appreciate calculating the odds and the probability of coming back after a massive drawdown is unlikely and, even if you're successful, you're facing burnout.

Bottom line: control risk and avoid massive drawdowns because doing so will help you protect your downside, and your upside will likely take care of itself as a result.

Livermore had a colorful life and career that began in the obscure countryside of New England and later blossomed in New York at the turn of the 20th century. Though his career was marked by a series of booms and busts, and ultimately tragedy, his sharp reasoning, objective assessment of human nature, the underlying dynamics of the market, and his ability to size up general themes in the market and then translate that into effective action to profit from those themes serve as a working model for you and countless traders of every experience level on how to grow into a successful trader.

Billy Williams

Billy Williams has been trading the markets for 27 years, specializing in momentum trading with stocks and options.

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