Monday, September 04, 2006

LIVERMORE THE WORLD'S GREATEST SPECULATOR

Jesse Lauriston Livermore (July 26, 1877 - November 28, 1940) was a notable early 20th century stock trader. He was famed for making and losing several multi-million dollar fortunes and short selling during the market crashes of 1907 and 1929.

Born in South Acton, Massachusetts, Jesse Livermore started his trading career at the age of fifteen. He ran away from home with his mother's blessing to escape a life of farming his father wished him to have. He then began his career by posting stock quotes at the Paine Webber brokerage in Boston.

While working, he would write down certain hunches he had about future market prices, which he would check for accuracy later. A friend convinced him to put in his first money trade. He risked $5 and made his first profit. With these humble beginnings, he began trading for himself.
At the age of fifteen, he had earned profits of over $1000 (a significant amount of money in the early 1890s).
In the next several years, he made his money at the bucket shops. These were places where people would enter trades, but no actual trades were executed; they were betting against the house. Most people would lose money to the bucket shops due to fluctuations in stocks that would wipe out their slim margins. Livermore would regularly beat the bucket shops and was eventually banned from them. He would then devote his energies towards trading in legitimate markets. This change would lead him to devise a new set of rules to beat the market.
During his lifetime, Livermore gained and lost several multi-million dollar fortunes. Most notably, he was worth $3 million and $100 million after the 1907 and 1929 market crashes, respectively. He would lose both fortunes, but not recover the losses of the fortune he had in 1929. Apart from his success as a securities speculator, Livermore left traders a working philosophy for trading securities that emphasizes increasing the size of one's position as it goes in the right direction and cutting losses quickly.
Ironically, Livermore sometimes did not follow his rules strictly. This lack of adherence was the main reason for his losses after making his 1907 and 1929 fortunes.
The popular book "Reminiscences of a Stock Operator", by Edwin Lefevre, reflects many of those valuable lessons. Livermore himself wrote a less widely read book, "How to trade in stocks; the Livermore formula for combining time element and price". It was published in 1940, the same year he committed suicide.
Livermore made his money by following trends in market prices. He would choose a particular stock or commodity to buy or short based on its price and volume action. Then, he would establish relatively small initial positions. He would then add to his positions if they made him money or sell them if they were unprofitable. This technique resulted in large gains and small losses. He also bucked the trends of prevailing sentiment of the markets at critical points. For example, when people were exuberant about the markets near the tops in 1907 and 1929, he began short-selling.

After devising his rules, he had temporarily disregarded them in 1906. He repeatedly shorted Union Pacific in a rising market and kept adding to his position even when the stock temporarily rose based on a strange hunch he had. He couldn't explain the hunch, but he had a strong urge to short the company. A few days later, the San Francisco Earthquake of 1906 struck. Livermore kept adding to his position and made $250,000.

He first became famous In 1907, when he short sold the market as it crashed. He noticed conditions where a lack of capital existed to buy stock. Accordingly, there would be drops in prices with too many sellers, driven by margin calls. With the lack of capital, there would be no buyers in sight to absorb the sold stock, further driving down prices. The market then crashed to the point that there would be insolvency of the stock market system and even the national economy itself.

A common story heard was that during the crash of 1907, J. P. Morgan himself pleaded with Livermore to stop pounding the market down. After the crash and its aftermath, he was worth $3 million.

He proceeded to lose 90% of that 1907 fortune on a blown cotton trade. He violated many of his key rules; he listened to another person's advice (he preferred working alone) and added to a losing position. He continued losing money in the flat markets from 1908-1912. He was $1 million in debt and declared bankruptcy. He proceeded to regain his fortune and repay his creditors during the World War I bull market and resulting downtrend.

He owned a series of mansions around the world each fully staffed with servants, a fleet of limousines, and a steel-hulled yacht for trips to Europe. He married Dorothy, a beautiful Ziegfeld Follies showgirl when he was about 40 years old.

He continued to make money in the bull markets of the Roaring 20's. In 1929, he noticed market conditions similar to that of the 1907 market. He began shorting various stocks and adding to his positions and they kept declining in price. When just about everyone in the markets lost money in the Wall Street crash of 1929, Livermore was worth $100 million after his short-selling profits.

Through unknown mechanisms, he yet again lost much of his trading capital, accumulated through 1929. Thus, in 1934, he declared bankruptcy for a second time.
Although untouchable trusts and cash assets at his death totalled over $5 million, he had failed to regain his trading confidence by his death. A lifelong history of clinical depression had finally become dominant in his final years.

In 1935, Dorothy shot their son, Jesse Livermore Jr., in a heated drunken argument. The son survived, but the episode caused a scandal. He would divorce Dorothy and marry another woman whose previous three husbands had all committed suicide. This would prove to be a grim harbinger.

In 1940, his book on trading strategies, building on the founding fame of 'Reminiscences of a Stock Operator' was published. In the Sherry-Netherland Hotel on November 28, 1940, he committed suicide. His clinical depression was cited as a factor. Today Livermore is regarded by many professional traders to be the greatest trader in history.

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