12 Lessons from Reminiscences of a Stock Operator

Last Updated on January 6, 2020 by Mark Ursell

Written almost 100 years ago, few trading books have had the influence and lasting popularity as Edwin Lefèvre’s trading classic. This extraordinary book is still relevant today, and this article has some fascinating lessons from Reminiscences of a Stock Operator.

The book is mostly biographical and was written about Jesse Lauriston Livermore. Stock and commodity trader. The events depicted in the book took place from the end of the 19th century to the early 1920s.

Check out the book on Amazon

The best available version of the book is the 2010 version with historical notes by Jon Markman and a foreword by legendary trader Paul Tudor Jones. The notes help the modern reader understand the context of Livermore’s life and trading beliefs.

Livermore lived in the age of telegrams, ticker machines and manually updated quote boards. It is difficult to imagine in these days of trading via smartphones, instant information via social networks, and high-frequency trading. Surely this book is obsolete?

But, as Livermore himself points out, people do not change. The twin forces of fear and greed are the same today. People still dream of getting rich quick. Other people take shortcuts and try to trick other people. There are still insiders and outsiders, each trying to take advantage of the other.

First and foremost, this is a how-to book about trading. The book repeats the essential messages time and again. It is also an unforgettable historical account of the financial markets that is interesting as well as useful to any serious trader.

Always be a Student of the Markets

“I put down my observations in it. It was not a record of imaginary transactions such as so many people keep merely to make or lose millions of dollars without getting the swelled head or going to the poorhouse. It was rather a sort of record of my hits and misses. I was most interested in whether I had observed accurately; in other words, whether I was right.”

“A speculator must not be merely a student he must be both a student and a speculator.”

From the very beginning, Livermore was fascinated by the markets and tried to understand them. In his early years in the bucket shops of New England, he developed his skills at tape reading. To remember the movement patterns for each stock, he would write his theories down in notebooks. After a while, he found that he was able to predict how a stock would behave based on its price movement. He placed his first trade at the tender age of 14 and soon left his job to become a full-time trader.

His quantitative approach to price action will be familiar to many modern-day traders. At first, Livermore was a purely technical trader. His system gave him an insight into the short-term movement of stock prices, and he traded on these fluctuations. His style of trading was to develop over many years but he continually studied and researched the markets.

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Don’t Worry too Much About Why the Price Moved

“The reason for what a certain stock does today may not be known for two or three days, or weeks, or months. But what the dickens does that matter? Your business with the tape is now – not tomorrow. The reason can wait. But you must act instantly or be left.”

Livermore’s trading success forced him out of the smaller bucket shops, and he was soon trading at the largest company in New England. But even here he was exposed to sharp practices. Trading a large short position, he realized that the price was not behaving the way it should do. Sensing that something was up he quickly closed out the trade moments before insiders squeezed the price sharply upwards.

Throughout the book, Livermore describes times where he closed or changed his position based on how the price behaved. There is always a reason for why prices move. But as traders, we cannot expect to understand why at the time. If prices move contrary to expectations, we need to accept that our theory might be wrong. The shorter your timeframe the quicker your thinking should be.

Our Best Trading Lessons are Taught by the Markets

“The game taught me the game. And it didn’t spare the rod while teaching.”

Livermore arrived in New York flush from his success in the bucket shops. He knew his price action system could beat the markets, but he needed to move on to trading at a proper brokerage. It took him a while to realize that his system was not profitable outside of the bucket shops. Transaction costs and delays meant that he was not able to buy and sell quickly enough to make a profit. He continued trading in New York but before the end of the year his account was wiped out and he was broke.

Every time we have a significant loss in the markets, there is a lesson to be learnt. It is our responsibility to learn these lessons. Simple things like analyzing our trades and keeping a trading diary are crucially important to developing our trading method.

Take the Time to Plan your Strategy

“I always made money when I was sure I was right before I began. What beat me was not having brains enough to stick to my own game – that is, to play the market only when I was satisfied that precedents favored my play.”

Livermore continued his same price action strategy despite losing his lack of success in New York. He decided to rebuild his account by trading back in the bucket shops again. He knew that his strategy worked in the bucket shops. Travelling to St. Louis and using a false name he was able to trade and earn some money.

Losing traders do not plan their strategy. They act impulsively and allow themselves to be pulled about by the whims of the market. Livermore planned his trades in detail. He studied price action is incredible depth and also learned and studied fundamentals.

It was my sitting that made me money

“It was never was my thinking that big money for me. It always was my sitting. Got that? My sitting tight!”

Livermore made his reputation as a successful short-seller during the Panic of 1907. Before the panic, he had been selling short in accordance with his views on the market and the general economy. As the situation got worse, he stayed short and saw the paper value of his positions increase. A succession of crises hit the markets and in October 1907 the markets began to crash. Finally, the money markets seized up and required a personal intervention by financier JP Morgan to organize a bailout. At the bottom of the market, with the New York Stock Exchange close to collapse, Livermore finally took profits on his positions. He made his first million-dollar gain, but most importantly he realized that he had finally learnt what it was to trade intelligently in a big way.

The only ways that we can make money trading the markets is by making more money on our winning trades than we lose on our losing trades. Having a few really big winning trades makes it much easier to be profitable.

Learn to Trust Your Own Judgement

“A man must believe in himself and his judgment if he expects to make a living at this game. That is why I don’t believe in tips.”

“Tips! How people want tips! They crave not only to get them but to give them.”

In Reminiscences, Livermore describes how a sneaky tipster tried to get him to buy a stock by introducing the idea through his wife. Knowing how resistant he was to tips, the person approached his wife telling her that there was easy money to be made by buying shares in a tin producing company. The plan to get the wife to suggest the company to Livermore backfired when his wife decided to invest herself in the company. The price quickly declined, and his wife soon lost money on her trade. The situation was worse because Livermore himself was selling the stock short!

Every single person in the world is affected by the suggestions of other people. Of course, as traders, we can take on board the opinions, thoughts and suggestions of others. But never take trades on someone else advice unless you agree with the trade yourself.

Traders are not Investors – Don’t Always Look for Value

“I never want to buy stocks too cheap or too easily.”

One of Livermore’s favorite tactics was to buy when a stock went above its ‘par’ price. This referred to the original value of the stock when it was issued. This could be compared to buying when a stock trades above a significant range or whole number. He would then buy more if the price continued to increase.

No matter how high the price is, the market can always go higher. Equally, however cheap a market looks, it can always go lower. Livermore does not recommend blindly pyramiding every trade but rather to make sure you take the maximum value out of your good trades.

Guard Against our Own Nature

“I sometimes think that speculation must be an unnatural sort of business, because I find that the average speculator has arrayed against him his own nature. The weaknesses that all men are prone to are fatal to success in speculation.”

Livermore is aware enough to give examples of his own psychological weak points. He tells a story about how he bought a set of Walter Scott novels for $500. This occurred when a salesman talked him into the sale. As soon as he signed the contract, he realized that he did not want the books, had nowhere to put them and nobody to give them to! According to Livermore, this shows how he is not immune to the influence of a persuasive personality. This weakness was to cost him millions of dollars trading in cotton as he listened to the incorrect advice of a persuasive cotton dealer.

We all know how hard it is to identify our own strengths and weaknesses. Most of the time we can get by avoiding certain situations or relying on other people to make allowances. Unfortunately, the financial markets will ruthlessly exploit a weakness that causes us to make trading errors. We must always be honest with ourselves and make sure that any weaknesses do not affect our trading.

Trade the Line of Least Resistance

“It would not be so difficult to make money if a trader always stuck to his speculative guns – that is, waited for the line of least resistance to define itself and began buying only when the tape said up or selling only when it said down”

The book mentions time and time again about the tendency of markets to trend. Livermore places crucial importance on his judgement about whether stocks are in a bull market or a bear market. This judgement is partly based on price action and partly based on his view of the fundamental factors. Take a step back from the chart and the current economic conditions and decide whether you are bullish or bearish. Once you have decided, only trade in that direction.

Be Careful Trying to Pick Tops and Bottoms

“Never try to sell at the top. It isn’t wise. Sell after a reaction if there is no rally.”

In 1916 Livermore took about 3 million dollars of trading profits. He was bullish with everyone else at the beginning of the year but gradually moved to the bearish side. He noticed that the previous leading stocks had stopped rising and had been overtaken by new companies. He therefore traded long on the new leaders but opened short positions on the previous leaders. He followed this tactic until the new leading stocks also weakened. Finally, the bear market kicked in and prices broke further prompting Livermore to double to short positions.

Livermore makes the point that the bear market conditions can start long before prices start to fall. In this case, it is wise for the trader to wait for prices to start to fall before entering a large short position. Exactly the same applies in a bear market, it can take months or even years before prices are able to start going higher.

Begin with the End in Mind

“Experience has taught me that a man can always find an opportunity to make his profits real and that this opportunity usually comes at the end of the move.”

Being on the right side of the trade meant that Livermore was able to benefit from unexpected large moves in his favor. The 1916 fall in stock market prices took time to arrive. But once it did arrive each successive lurch downwards increased his paper profits. Such a large position can be difficult to exit without pushing the market against you. Livermore took his profits only when the market had moved a significant distance and was able to absorb all his outstanding short positions.

As a big trader, Livermore always had to have a careful eye on how he was going to exit a position. Smaller traders do not usually need to worry about how their buying and selling will affect the market. However, every time we enter a trade we must always plan how we are going to get out of it. We should always know our exit, whether the position is profitable or not.

Time Moves On but Some Things Stay the Same

“Most of the tricks, devices and expedients of bygone days are obsolete and futile; or illegal and impracticable.”

but

“Fear and hope remain the same; therefore the study of the psychology of speculators is as valuable as it ever was.”

Many of the subjects referred to in the book are no longer an issue for modern-day traders. Market supervision is much stronger than it used to be. Markets move much quicker than they used to. However, we can always rely on the markets to reflect the people that invest and trade in them. This means that all markets will be prone to behaving irrationally.

And Finally… Patience

“Slow as my progress seems now, I suppose I learned as fast as I possibly could, considering that I was making money on balance.”

Be patient. It took one of the greatest traders of his generation 12 years to understand the markets well enough to make big money. Despite all his skill and hard work he still blew up his account on multiple occasions.

Lessons from Reminiscences of a Stock Operator – How You Can Improve Your Trading

If you’ve enjoyed reading these lessons from Reminiscences of a Stock Operator, you might want to check out the link below to see how you can power-up your trading results.