Jesse Livermore: one of the greatest traders of all time

There are plenty of well-known investors with long and successful track records. John Templeton, Warren Buffett and Ray Dalioare three obvious examples.

There are also plenty of traders, those who move in and out of positions on a weekly, daily or even hourly basis, who have made fortunes. Indeed, Jack Schwager has profiled many of them in his 'Market Wizards' books.

However, far fewer of these individuals have careers spanning two or more decades. In part, this is because most traders either burn out, or make enough to retire and escape with their wealth.

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Those who stay in the game for any length of time invariably 'blow up', giving back most of their gains, and are forced to quit. As the saying goes, "there are old traders and there are bold traders but there are no old, bold traders."

However, there was one trader who made billions in today's money and lasted in the market for more than 30 years. Even though he had some large setbacks - losing all he had and more - he managed to rebuild his fortune twice. His market timing skills were so impressive that he even made money during the Wall Street Crash.

Sadly, he eventually proved the truth of the old adage ending his own life at the age of 63. Yet many modern traders still swear by lessons they've learned from observing his career even although he was born more than 100 years ago.

His name was Jesse Livermore.

How did Livermore start out?

Livermore is best known as the subject of Reminiscences of a Stockbroker, a thinly-disguised biography first published in 1923. It was written by financial journalist Edwin Lefevre, who interviewed Livermore extensively for the book.

Born in 1877, Livermore, started his trading career in his teens, after working as a brokerage clerk. Initially, he traded in what were known as 'bucket shops'. These were firms that offered investors the chance to trade in shares without owning them. In effect, they were the 19th century version of spread betting firms.

Because they didn't rely on brokers, they were much better for small investors who wished to trade frequently, offering credit and prices based on the ticker, not execution. In other words, transaction costs could be lower because no one ever owned the underlying stocks.

Like spread betting firms, bucket shops relied on customers either cancelling each other out or consistently making the wrong decisions. Sadly for them, Livermore kept getting his bets right.

As a result he was quickly banned from all the shops in town, though not before making $10,000 by the age of 20 (equivalent to $280,000 today). This enabled him to start trading through proper brokers (although he would briefly return to the bucket shops after taking a massive loss during his early attempts to use a broker).

From 1897 to his second (and final) bankruptcy in 1934, Livermore played both the commodity and the stock markets. He made millions from trading. But he also lost millions, and ended up having to declare bankruptcy for the first time in 1912, a step he claimed to have taken partly to get his creditors off his back and let him focus on making a comeback.

And, unlike most other bust traders, that's exactly what he did. He managed to repay his creditors. At his peak in the early 1930s he was worth over $100m ($2.4bn in 2011 money). But there were many troughs and further comebacks along the way.

So how did he make his money?

Livermore's main strategy was 'tape reading': monitoring the price movements of stocks, looking to see if there was a sudden change in direction. If this change continued with enough force he would then follow it until, in his view, it had ended.

This approach is sometimes called 'trend following'. It is important to note that this expressly did not involve attempting to buy stocks at the bottom. Indeed, he was quite clear that the trader should be happy to wait until stocks had already advanced before piling in.

Of course, this approach of waiting for the trend to confirm itself gave up some of the upside. However, he argued that when he did move in he was rarely wrong. As he put it: "Do you wish to gamble blindly in the hope of getting a great big profit or do you wish to speculate intelligently and get a smaller but much more probable profit?"

What about the fundamentals?

Livermore thought that many investors who tried to use valuation techniques to determine whether a stock or commodity was properly priced tended to act too early. They therefore risked losing out, or even being forced out of a position while they waited for the market to catch up with them.

However, unlike many charting purists, he didn't ignore fundamentals when making a decision. Indeed, when he traded commodities he frequently used them to guide his overall view although he still used tape reading to time his buying and selling.

His two biggest coups came from shorting the market before crashes in 1907 and 1929. Indeed, at one point during the panic of 1907, JP Morgan actually implored Livermore not to go short the market for fear of making things even worse which shows just how much clout he had.

In each case, Livermore was struck by the fact that so much of the share buying that had pushed prices up was done on credit. He realised that at some point this would have to be unwound, causing mayhem.

As was shown by the stock market crash in 2008 and subsequent rally in early 2009, and the sensitivity of the market these days to money printing, the amount of liquidity in the system plays an important part in pushing prices higher or lower.

Can you learn any lessons from his failures?

Livermore's failures were as instructive as his successes. He always stressed the importance of not listening to "hot tips". As with Bridgewater's Ray Dalio, he felt that a speculator should do his own homework and question everything.

He also stressed the importance of money management, which is especially important if you are going to do a lot of high-risk trading. One strategy that he endorsed was to take part of the profits from every trade and put it in a savings account. He was honest enough to admit that he didn't always follow his own advice.

On November 28 1940, aged 63, he shot himself in a Manhattan hotel. Despite leaving a suicide note in which he described himself as a "failure", he still managed to leave $5m behind for his heirs after his death.

Livermore's sad end should be a reminder about the need to retain perspective. Although trading can be a way to enhance your wealth, it should not become an obsession. There are other ways to secure your future that are less stressful. As Livermore himself once pointed out, if your investments are keeping you awake, you need to sell to your sleeping point.

If you're at all interested in investing, you must read Reminiscences of a Stock Operator. It's got everything from financial history to insights into investor psychology that years of research by behavioural economists' have frankly done very little to improve upon. If you've never read it, get a copy and put it at the top of your reading pile now you won't regret it.