(Notes from "Reminiscences of a Stock Operator", Ch.7 (1922))
|Jan 1, 2017||Public post|
Some notes from one of the “Trading Bibles” most of my financial friends know well.
Chapter 7 offered the stripped down mechanics of trading for Livermore, taking it from the appraisal of “conditions” down to trading actual securities and connecting it with the common daily experience of the man on the street, the “average man”.
The “average man” is focused on “tips”, entranced by the magic of individual ideas.
This is one of the best paragraphs from the "Traders' Bible", which I have split down the middle into two amazing observations, and covers two powerful concepts about markets and the human condition in markets:
“I never hesitate to tell a man that I am bullish or bearish. But I do not tell people to buy or sell any particular stock. In a bear market all stocks go down and in a bull market they go up. I don’t mean of course that in a bear market caused by a war, ammunition shares do not go up. I speak in a general sense."
"But the average man doesn’t wish to be told that it is a bull or a bear market. What he desires is to be told specifically which particular stock to buy or sell. He wants to get something for nothing. He does not wish to work. He doesn’t even wish to have to think. It is too much bother to have to count the money that he picks up from the ground.”
I myself was in the same camp, and thought about specific ideas, as if that were all there was to speculation, that it was all about some magic/holy grail of a specific trade. Fortunately, like many fellow speculators, risk-takers from all walks of life and market observers, I learned there was a lot more to markets than just individual "tips".
“Well, I wasn’t that lazy, but I found it easier to think of individual stocks than of the general market and therefore of individual fluctuations rather than of general movements. I had to change and I did.”
It took me a long time to learn the following about trading, which is contrary to human impulses but essential for speculators who specialize in following price and what is now referred to as "trend-following":
“People don’t seem to grasp easily the fundamentals of stock trading. I have often said that to buy on a rising market is the most comfortable way of buying stocks. Now, the point is not so much to buy as cheap as possible or go short at top prices, but to buy or sell at the right time. When I am bearish and I sell a stock, each sale must be at a lower level than the previous sale. When I am buying, the reverse is true. I must buy on a rising scale. I don’t buy long stock on a scale down, I buy on a scale up.”
Okay, what does he mean by "scale up" and so on? What is great that Livermore lays it out with a specific scenario to help walk the reader through the actual implementation of his mental framework and process as a speculator. You don't have to read the following massive block of text but you can almost imagine this man, perhaps he is outside his office, on his yacht, with his fishing gear, enjoying a long break, about to explain to us what he means with an example:
“Let us suppose, for example, that I am buying some stock. I’ll buy two thousand shares at 110. If the stock goes up to 111 after I buy it I am, at least temporarily, right in my operation, because it is a point higher; it shows me a profit. Well, because I am right I go in and buy another two thousand shares. If the market is still rising I buy a third lot of two thousand shares. Say the price goes to 114. I think it is enough for the time being. I now have a trading basis to work from. I am long six thousand shares at an average of 111-3/4, and the stock is selling at 114.
"I won’t buy any more just then. I wait and see. I figure that at some stage of the rise there is going to be a reaction. I want to see how the market takes care of itself after that reaction. It will probably react to where I got my third lot. Say that after going higher it falls back to 112-1/4, and then rallies. Well, just as it goes back to 113-3/4 I shoot an order to buy four thousand-at the market of course. Well, if I get that fouf thousand at 113-3/4 I know something is wrong and I’ll give a testing order-that is, I’ll sell one thousand shares to see how the market takes it. But suppose that of the order to buy the four thousand shares that I put in when the price was 113-3/4 I get two thousand at 114 and five hundred at 114-1/2 and the rest on the way up so that for the last five hundred I pay 115-1/2. Then I know I am right.
"It is the way I get the four thousand shares that tells me whether I am right in buying that particular stock at that particular time-for of course I am working on the assumption that I have checked up general conditions pretty well and they are bullish. I never want to buy stocks too cheap or too easily.”
Everything starts with a general concept and framework and then it is broken down into details and mechanics. Trading includes accounting for the bankroll of the trader, market conditions, and specific price action. You can be "right" about a broad idea about the economy or industry but then what?
Ideas are great, but then they must be reduced to the specific action of execution. Livermore's speculative process included both the big picture of markets as well as specific trade management, and he could describe a market as "bullish" or "bearish" and then was able to take specific risks and adjust accordingly.
I have posted often with broad market opinion and some specific ideas but even then there is more to do, in terms of entry, trade size, stop loss pricing and plans for both success and failure for each idea. Regular readers are well acquainted with my content and I hope they are building a process to help them both a framework to enable them to manage both market opinion and market risk-taking.