When a "hunch" is more than a hunch

(Meditations on a Stock Operator, On "Reminiscences" Chapter 6)

Meditations on a Stock Operator Chapter 6: When a "hunch" is more than a hunch.

Livermore had practiced his craft, making mistakes and learning and growing, since age 14, and developed a successful admixture of two skillsets: businesslike mechanical execution of trades and a sharp qualitative interpretation of price and herd behavior.

As a result, when I read about the idea of trading on a "hunch", as he relates in this chapter, I interpret it as shorthand for much more than a random whim. Many talk about events in their jobs as including moments of near "sixth sense" abilities. I suspect these moments are really epiphanies,  a flowering from a perhaps years of experience hardwired into the mind, triggered by internalized pattern recognition.

A situation which has a familiar or "déjà vu" sense is less about mysticism and more about memory. It might not be about repetition but about rhyming and pattern recognition.

"In the spring of 1906 I was in Atlantic City for a short vacation. I was out of stocks and was thinking only of having a change of air and a nice rest..."

"You may remember the story I told you about that time when I was short thirty-five hundred Sugar in the Cosmopolitan and I had a hunch something was wrong and I'd better close the trade? Well, I have often had that curious feeling. As a rule, I yield to it. But at times I have pooh-poohed the idea and have told myself that it was simply asinine to follow any of these sudden blind impulses to reverse my position. I have ascribed my hunch to a state of nerves resulting from too many cigars or insufficient sleep or a torpid liver or something of that kind."

 "When I have argued myself into disregarding my impulse and have stood pat I have always had cause to regret it. A dozen instances occur to me when I did not sell as per hunch, and the next day I'd go downtown and the market would be strong, or perhaps even advance, and I'd tell myself how silly it would have been to obey the blind impulse to sell. But on the following day there would be a pretty bad drop. Something had broken loose somewhere and I'd have made money by not being so wise and logical. The reason plainly was not physiological but psychological."

Right here, we all recognize those moments of doubt, "double-think" and “analysis paralysis”. You may have done the hard work, day after day, year after year, and paid your "10,000 hours" dues, but you still have a confidence issue. Can you trust yourself that you have trained for a moment and that it has arrived and that you might in fact be ready?

"I want to tell you only about one of them because of what it did for me. It happened when I was having that little vacation ...It was not noon yet, and we walked up slowly to kill time and breathe the salt air. Harding Brothers had a branch office on the Boardwalk and we used to drop in every morning and see how they'd opened. It was more force of habit than anything else, for I wasn't doing anything...

"I stared at the last price on the board until I couldn't see any figures or any board or anything else, for that matter. All I knew was that I wanted to sell Union Pacific and I couldn't find out why I wanted to."

"A million things could happen. But I can't promise you that any of them will. I can't give you any reasons and I can't tell fortunes...I don't know why I want to sell it. I only know I do want to..."

"On the following day, when fuller reports came in, the market began to slide off, but even then not as violently as it should. Knowing that nothing under the sun could stave off a substantial break I doubled up and sold five thousand shares. Oh, by that time it was plain to most people, and my brokers were willing enough. It wasn't reckless of them or of me, not the way I sized up the market. On the day following, the market began to go for fair. There was the dickens to pay. Of course I pushed my luck for all it was worth. I doubled up again and sold ten thousand shares more. It was the only play possible."

Seeing further confirmation on his more than a whim "hunch", Livermore added to his trade.

"I wasn't thinking of anything except that I was right-100 percent right-and that this was a heaven-sent opportunity. It was up to me to take advantage of it. I sold more. Did I think that with such a big line of shorts out, it wouldn't take much of a rally to wipe out my paper profits and possibly my principal ? I don't know whether I thought of that or not, but if I did it didn't carry much weight with me. I wasn't plunging recklessly. I was really playing conservatively. There was nothing that anybody could do to undo the earthquake, was there? They couldn't restore the crumpled buildings overnight, free, gratis, for nothing, could they? AH the money in the world couldn't help much in the next few hours, could it?"

Livermore refers to the San Francisco earthquake and the reaction time to the "news". Price plus his "hunch" was enough for him to act and sell short Union Pacific shares.

"I was not betting blindly. I wasn't a crazy bear. I wasn't drunk with success or thinking that because Frisco was pretty well wiped off the map the entire country was headed for the scrap heap. No, indeed! I didn't look for a panic. Well, the next day I cleaned up. I made two hundred and fifty thousand dollars. It was my biggest winnings up to that time. It was all made in a few days. The Street paid no attention to the earthquake the first day or two. They'll tell you that it was because the first despatches were not so alarming, but I think it was because it took so long to change the point of view of the public toward the securities markets. Even the professional traders for the most part were slow and shortsighted. "

Later on Livermore would also vacation at Saratoga Springs.

"That summer I went to Saratoga Springs. It was supposed to be a vacation for me, but I kept an eye on the market. To begin with, I wasn't so tired that it bothered me to think about it. And then, everybody I knew up there had or had had an active interest in it. We naturally talked about it. I have noticed that there is quite a difference between talking and trading. Some of these chaps remind you of the bold clerk who talks to his cantankerous employer as to a yellow dog-when he tells you about it."

"Of course I watched the market. With me, to look at the quotation board and to read the signs is one process. My good friend Union Pacific, I noticed, looked like going up. The price was high, but the stock acted as if it were being accumulated. I watched it a couple of days without trading in it, and the more I watched it the more convinced I became that it was being bought on balance by somebody who was no piker, somebody who not only had a big bank roll but knew what was what. Very clever accumulation, I thought."

AGAIN, Price plus experience was telling Livermore something new about a stock he just shorted.

"As soon as I was sure of this I naturally began to buy it, at about 160. It kept on acting all hunky, and so I kept on buying it, five hundred shares at a clip. The more I bought the stronger it got, without any spurt, and I was feeling very comfortable. I couldn't see any reason why that stock shouldn't go up a great deal more; not with what I read on the tape."

"All of a sudden the manager came to me and said they'd got a message from New York-they had a direct wire of course-asking if I was in the office, and when they answered yes, another came saying: "Keep him there. Tell him Mr. Harding wants to speak to him."

At this point a friend of Livermore, "Harding" (likely to have been brokerage legend Edward F. Hutton) calls him to do him a "favor":

"I said I'd wait, and bought five hundred shares more of UP. I couldn't imagine what Harding could have to say to me. I didn't think it was anything about business. My margin was more than ample for what I was buying. Pretty soon the manager came and told me that Mr. Ed Harding wanted me on the long-distance telephone.

"But he came back at me: "You can't expect a miracle to save you every time you plunge in that stock. Get out while you've still got a chance," he said. "It's a crime to be long of that stock at this level-when these highbinders are shoveling it out by the ton."

"The tape says they're buying it," I insisted.

"Larry, I got heart disease when your orders began to come in. For the love of Mike, don't be a sucker. Get out! Right away. It's liable to bust wide open any minute. I've done my duty. Good-by!" And he hung up.

As we are all prone to do, we can be swayed by friends and family.

"I sold out all my Union Pacific. Of course if it was unwise to be long of it it was equally unwise not to be short of it. So after I got rid of my long stock I sold four thousand shares short..."

Livermore, like some more experienced traders, will see a “short” if a trade is no longer a buy/long, or vice-versa.

"The next day the directors of the Union Pacific Company declared a 10 per cent dividend on the stock. At first nobody in Wall Street believed it. It was too much like the desperate manoeuvre of cornered gamblers. All the newspapers jumped on the directors. But while the Wall Street talent hesitated to act the market boiled over. Union Pacific led, and on huge transactions made a new high-record price..."

Livermore had in fact not only be prone to a friend's persuasion, it was also a violation of his rule against taking tips, and that includes those against an experienced trader's skill.

"Of course I realized, the moment I heard the news of the declaration of that unprecedented 10 per cent dividend, that I got what I deserved for disregarding the voice of experience and listening to the voice of a tipster. My own convictions I had set aside for the suspicions of a friend, simply because he was disinterested and as a rule knew what he was doing"

"All I had in the world was up as margin in Harding's office. I was neither cheered nor made stubborn by the knowledge of that fact. What was plain was that I had read the tape accurately and that I had been a ninny to let Ed Harding shake my own resolution. There was no sense in recriminations, because I had no time to lose; and besides, what's done is done. So I gave an order to take in my shorts. The stock was around 165 when I sent in that order to buy in the four thousand UP. at the market. I had a three-point loss on it at that figure. Well, my brokers paid 172 and 174 for some of it before they were through. I found when I got my reports that Ed Harding's kindly intentioned interference cost me forty thousand dollars. A low price for a man to pay for not having the courage of his own convictions! It was a cheap lesson."

Instead of browbeating himself, he soon pivoted again back to his original stance:

"I wasn't worried, because the tape said still higher prices. It was an unusual move and there were no precedents for the action of the directors, but I did this time what I thought I ought to do. As soon as I had given the first order to buy four thousand shares to cover my shorts I decided to profit by what the tape indicated and so I went along. I bought four thousand shares and held that stock until the next morning. Then I got out. I not only made up the forty thousand dollars I had lost but about fifteen thousand besides. If Ed Harding hadn't tried to save me money I'd have made a killing. But he did me a very great service, for it was the lesson of that episode that, I firmly believe, completed my education as a trader."

HERE is the final paragraph and the lesson:

"It was not that all I needed to learn was not to lake tips but follow my own inclination. It was that I gained confidence in myself and I was able finally to shake off the old method of trading. That Saratoga experience was my last haphazard, hit-or-miss operation. From then on I began to think of basic conditions instead of individual stocks. I promoted myself to a higher grade in the hard school of speculation. It was a long and difficult step to take."

Some questions to close this out:

Will you work long enough, in a consistent and constant fashion, to develop the skills to act in a way that almost seems based upon a whim to a neophyte but is really a distillation of a lot of study and experience?

Can you then trust yourself and your methodology, once you have achieved some level of mastery?

Can you think in terms of the big picture, the framework of your process, portfolio and professional approach to your trading plans?