Big Mistakes: Jesse Livermore

Risk management can reduce the impact of unforced errors

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Jun 18, 2019
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While Jesse Livermore "was a larger”than”life, full”blooded character who happened to embody every great trading maxim of the time,” he frequently disregarded those maxims, according to Michael Batnick in his 2018 book, “Big Mistakes: The Best Investors and Their Worst Investments.”

The author led into his chapter on Livermore by discussing the place of maxims, or rules of thumb, in investing. It’s a confusing place because maxims mask complexity and are too simplistic. At the same time, given the many variables and circumstances, they are also essential to get past all the noise. Such crosscurrents also flowed through Livermore’s career; as Batnick wrote:

“Jesse Livermore is the most famous, maybe the first famous, market speculator. The lesson that investors should learn from Livermore is how dangerous rules of thumb can be. If you catch yourself saying “buy when there is blood in the streets,” it's a good idea to remember that the man who basically invented market phrases couldn't even stick to them. Buy low, sell high sounds great, and the idea is, but like many things, it's easy to say, hard to do.”

Born in 1877, Livermore got a job as a board boy at Paine Webber at age 14. Just a year and a half after that, he went to a Boston bucket shop (shops that used many now-illegal brokerage practices) and made his first $10 investment. Another year and a half later, he had built his fortune to $1,200, quite a respectable sum at that time.

With that, he became a full-time speculator—and soon the bane of Boston’s bucket shops. So Livermore began a peripatetic life, beginning in New York City, where he met and went on to work with E.F. Hutton (the man; the company would come later). With his own $2,500 and another $22,500 of credit from Hutton’s firm, he began his new career.

In his trading and speculating, Livermore liked the short side, the practice of selling securities at a high price, buying them back at a lower price and pocketing the difference. In 1901, he shorted U.S. Steel (X, Financial) and Santa Fe Railroad. He used all his capital and used margin to leverage himself to 4:1. The end result? He lost $50,000 in a few hours and, at age 23, found himself broke and $500 in debt.

The lesson he took from this debacle was that his bucket shop experience was far from adequate in the realm of professional trading. While Hutton offered to credit him $1,000 to get started again, Livermore decided he needed more experience and went back to the bucket shops. That led him to St. Louis, where no one knew him (and he used a different name). The subterfuge wasn’t enough, and St. Louis wanted nothing more to do with him.

He returned to New York, paid back the $500 he owed and was holding $2,000 to trade. By age 28, he had accumulated $100,000 and was ready for a big trade. On a hunch, he began selling Union Pacific (UNP, Financial) shares short, doubling down several times. This time he exercised patience and ended up with $250,000, roughly $6 million in 2018 dollars.

While Livermore planned to take some time for himself and to reflect, he had another hunch and jumped back into the market, again on the short side. Very quickly he lost 90% of his recent windfall. Batnick quotes him as saying:

“I had made a mistake. But where? I was bearish in a bear market. That was wise, and I had sold stocks short. That was proper. But I had sold them too soon, and that was costly. My position was right, but my play was wrong.”

Livermore was soon back, though, and by the end of 1907 had accumulated $3 million. The next year he moved to Chicago to trade commodities full time; on his first venture, in cotton, he brought in another $2 million. Within months, he returned to New York with his $5 million.

He traded cotton once again, but this time with damaging results. He had been long cotton and long wheat, and despite the rules he had crafted for himself, decided to sell the winner and add to the loser. That, coupled with a double-cross by a business associate, cost him $4.5 million. In addition, “He hit a cold streak, and everything he touched turned into a loser.”

But Livermore was soon up and investing again, making and losing fortunes. The peak of his career came during the crash of 1929, while he was heavily shorted. When the worst of the crash was over, he was worth $100 million, about $1.4 billion in today’s dollars, and one of the richest people in the world.

Over 42 days in 1932, the market snapped back, regaining 93% of its value. Livermore was badly hurt because of his short holdings and, to add insult to injury, went long just as the bounce ended. By the middle of 1933, all his gains from 1929 had evaporated. He was not only broke by 1934, but also owed $5 million to creditors.

Adding to his troubles at the time were stringent rules from the new Securities and Exchange Commission. Batnick wrote, “Many of his tricks and strategies were now illegal and came with hefty punishment.”

He made one last attempt to come back in 1939, but that failed. In November 1940, he took his own life. In the final accounting, for the courts, his assets were far less than his liabilities.

To put perspective on Livermore’s life, Batnick observed, “It is somewhat ironic that the most quoted trader of all time exhibited such poor risk management. All the sayings and lessons he learned didn't save him from blowing up four times.” Livermore himself had said, “If a man is both wise and lucky, he will not make the same mistake twice. But he will make any one of the ten thousand brothers or cousins of the original. The mistake family is so large that there is always one of them around when you want to see what you can do in the fool”play line.”

Winding up the chapter, Batnick concluded:

“Risk management is a part of investing. Repeating mistakes is part of investing. It's all part of investing. If you focus on avoiding unforced errors, you won't need to rely on cute market phrases that sound really great but only provide a false sense of security.”

Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours.

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