A prudent speculator never argues with the tape. Markets are never wrong, opinions often are.” Quote by Jesse Livermore
Jesse’s Trading Style
The trading style of Jesse Livermore was speculative and he considered trade management a key component to his success. Jesse had numerous rules which he used for his speculative trades.
The Probe Trade and Pyramiding
Jesse Livermore always pyramided into his positions at continuously higher prices.
His first position he called a Probe which was basically a test trade. If Jesse was after a total position of 1000 shares he would conduct a test trade of say 200 shares.
If the stock triggered his stop-loss level then all he would lose was the loss on a 200 share position. If the stock continued upwards he would add another 200 shares.
He would continue this until he reached his total shares target.
He would normally split his total share position into three to five pyramiding positions with the last position being no more than 5% to 10% above the pivotal point.
Jesse’s reasoning for buying each subsequent position at higher prices was that each 200 share position must show an open profit before he would add another position.
Jesse based the decision on how to break up the total position on personal experience and would adjust the breakup according to the personality of the stock or commodity he was trading.
Stop-Loss
Jesse Livermore used a price percentage stop-loss where he would exit if his view was wrong. He called it his bucket shop rule where he used a 10% stop to exit his trade.
This was because of the 10% margin that was used when he traded through the bucket shops.
Using a stop-loss was radical in Jesse’s days as no one really used stops in those days.
Jesse Livermore was an early pioneer being one
of the first to use the stop-loss technique
Jesse was a master at sensing when a stock was not behaving as he was expecting and would often sell before the stock or commodity would decline by 10%.
He based his rule on the notion that the most he was prepared to lose on any one trade was 10%.
Margin Call
Speculators’ meeting a margin call by supplying additional funds was common practice in Jesse’s days. Jesse Livermore would never meet a margin call and if it came to that he would simply exit his trade.
In those days it was normal for speculators to hold onto their losing positions in the hope that prices would return so that they can exit breakeven.
This included stocks bought on margin. Jesse referred to these speculators as involuntary investors.
Cash Reserve
One of Jesse Livermore’s tactics was to only trade the best opportunities and spend the rest of the time sitting on the sidelines.
Jesse used playing poker as an analogy and did not believe in playing every hand. Unless he was confident he was going to make money he did not participate.
To Jesse Livermore, the preservation of trading capital was of prime importance.
He reasoned that if the speculator were to continuously trade with the marginal opportunities, then all that will end up happening is that their cumulative losses will deplete their trading account and when a good opportunity came along there would be insufficient capital left to make the trade.
Jesse Livermore was a firm believer in patience and having a reserve cash balance.
Let the Winners Ride
Jesse Livermore was essentially a speculative trader compared to today’s short-term traders such as swing traders and position traders. So long as the stock or commodity was behaving correctly, then he had an open profit and would let it ride.
He would only exit if the stock or commodities behavior deviated from its normal action.
Jesse reasoned that an open profit was just that, it is not locked in until all the positions taken are closed-out. He was willing to play with open profit and reasoned that if he lost this then what he lost was profit he never had in the first place.
He called open profits “the stock markets money” and basically only cared about closed-out profits as to him this was real profit – money in the bank.
Jesse’s rule was to stick with a winner and let it ride until he had a good reason to exit the trade.
When he exited a trade at a significant profit, Jesse would withdraw 50% of that profit from his trading account. This to Jesse was his pay check.