Livermore: The Million Dollar Blunder

In Chapter 6 of his book, How To Trade In Stocks, famous speculator Jesse Livermore discusses some critical mistakes that he made over his trading career. It is refreshing to see that even the very best speculators of all time are not immune to the occasional mistake or two. By discussing these mistakes, Livermore offers us a wonderful opportunity to learn and grow.

“In consideration of these general trading principles it should be said that too many speculators buy or see impulsively, acquiring their entire line at almost one price. That is wrong and dangerous.” – Livermore

Livermore argues that a speculator should never buy or sell impulsively. It is a much safer strategy to have a plan in place prior to buying or selling. Succussful traders should identify opportunities ahead of time and then when those opportunities present themselves, have a plan to scale into a position gradually.

By gradually scaling into a position in what Livermore calls “probes,” a speculator can permit the market to confirm that he is correct. If the first probe doesn’t show a profit, there is no need to make a second probe. A speculator can continue scaling into a position in this manner until his full investment is bought. Livermore points out that this method of scaling into a position can also be used on the short side.

“But careful timing is essential…impatience is costly.” – Livermore

Livermore used this quote to lead into a story about how he missed out on a million dollar profit in cotton. He talked about how he identified that the cotton market was poised for a big run and identified the pivotal point. But, he was impatient and rather than wait for the price to get to the pivotal point, he repeatedly tried to get in early. This ended up costing him $200,000 in losses before the cotton market even got to the pivotal point.

By the time the market got to his pivotal point, Livermore was so disgusted with his losses that he was no longer even watching it on his ticker. Therefore, he missed the entire run after the stock crossed his pivotal point, which would have give him a one million dollar profit.

There are two key lessons here. We must have the patience to wait for certain points to get into stocks. It does us no good to get in early or to chase after stocks that are extended. We also must keep our guard against getting frustrated with the entire market and tuning out for a period of time.

“The market will tell the speculator when he is wrong, because he is losing money.” – Livermore

Livermore uses this line to transition to discussing how a speculator needs to liquidate a position the instant that he realizes it is not correct. He advises taking the loss immediately so that the trader can clear his head and reassess the situation. This connects back to his probing strategy, where if the market isn’t showing you continued profits, something is wrong.

Livermore goes on to tell stories about times where his instincts have told him that it was time to sell out of a position even though there were no scientific signs. He claims that this feeling in his gut is almost always correct. He makes it a point to specify that this feeling comes from years and years of full time careful and meticulous study of the market. I think that far too many new traders wrongly believe that they possess this same gut instinct and then proceed to lose money on it.

“It cannot be said too often that in speculation and investment, success comes only to those who work for it.” – Livermore

Livermore closes the chapter by discussing a hypothetical situation in which a trader meets someone with “inside information.” This, of course, is the dream of every speculator who fantasizes about being Michael Douglas in Wall Street instead of Ed Sykota. Livermore illustrates that even if the insider is correct in telling the trader when to buy, as an insider, his interests will never be in line with telling the trader to sell. It will never benefit the insider for the trader to sell, ever.

Far too many people are looking to get rich quick from the market and they honestly believe inside information will do it. If there is one thing we have learned from all the investing classics and all the market wizards, it’s that the only sure way to long term trading success is hundreds of hours of study and a disciplined approach to the markets. There is no substitute for the hard work you must put in to be successful.