Book Summary: Reminiscences of a Stock Operator

Book: Reminiscences of a Stock Operator

Author: Edwin Lefevre

This is a book about exploits of Jesse Livermore, and is written by Edwin as if it were Livermore’s autobiography.  Jesse Livermore was a trader in late 19th and early 20th century–he traded by watching the tape.  One can be snooty about whether he was an investor in the truest sense, but from a simple profit perspective, that is besides the point except that he had particularly volatile returns (he went bankrupt several times). He traded securities for profits and he was successful by many standards. He is a colorful character, and it is hard not to be easily swayed by his logic, even if it’s ill-advised and sometimes even self-contradictory. For example, he says “A speculator must concern himself with making money out of the market and not with insisting that the tape must agree with him. Never argue with it or ask it for reasons or explanations. Stock-market postmortems don’t pay dividends.” I don’t agree with that, as one would want to learn from what transpired. Despite other similar statements, the book remains a gem.  Below, I note the lessons that I believe would be most applicable to me.

I am someone who likes to think that I make investment decisions based on valuation. I am not sure whether that is entirely true, as I may simply be investing based on other behavioral ticks that I am yet unaware of. But, I am certain that I’m not comfortable (knowingly) investing based on what many call “a gut feel”. I can freeze when markets panic, and I often laugh on sidelines as it roars up higher and higher. I couldn’t be a professional trader to save my life. This is a weakness. I need to incorporate the trader’s sense of markets for two reasons–one, because trading data can give valuable signals that I may be missing some key metric in my valuation, and two, because sometimes securities simply trade on a trend for months and years, without being “valued” in the truest sense. As a professional investor, I cannot sit out of the markets for years because valuation is not entirely agreeable (admittedly, one has to be very careful in this endeavor).

One last note before I begin the summary. Here’s one of the comments that Paul Tudor Jones makes about the book: “We have spent a lot of time in the last two questions discussing the rationale behind recent events in modern financial history and how it compared to that era. It is not fitting to end on this note. The whole point of Reminiscences was that all of those very serious economic issues should be largely irrelevant to a great operator. Yes, they are interesting to debate, important to know, but always secondary to the tale the tape tells us on a continual basis.” One of the guest speakers at Johnson said that before you follow someone’s advice on investing, you must make sure that you’re playing the same game. He said that we can’t follow Buffet’s investment style, for example, if we can’t invest in opportunities like he can. Goldman was not looking to pay you and I a 10% coupon for the benefit of investing with them, for example. So, as we look at Jesse’s advice, let us remember what he was–a brilliant trader, a fine speculator, but not a valuation investor. He never mentions ratios such as P/E or CF Yield, forget relatively esoteric things like cost of capital.

Basic Tenet:

Livermore says that the popular media and many participants themselves think of the market as a battlefield and the daily business as a fight. He says that it not useful to think of the market in this way. Instead, the business is merely a difference in one’s opinion of the basic conditions.

When to sell?

• “Of all speculative blunders there are few greater than trying to average a losing game.”
• When selling is absorbed in multiple small lots as opposed to a few transactions, sell everything, as there’s no buying power there.
• If one has a position in an equity, and other names in the group are showing weakness, the stock should be sold as markets tend to manifest a group-tendency.
• Here’s an excerpt that really cannot be improved upon by brevity: “Whereupon the average man, who never thinks of values but of prices, and is not governed in his actions by conditions but by fears, takes the easiest way; he stops thinking that there must be a limit to the advances. That is why those outsiders who are wise enough not to buy at the top make up for it by not taking profits. The big money in booms is always made first by the public, on paper. And it remains on paper.”
• Above all, sell down to the sleeping point. If the position begins affecting one emotionally, it may be too dangerous to hold.

When NOT to sell?

• Stand pat if the position is sound–i.e. one’s not bucking market trend or going against the basic conditions, even if people claiming to be insiders sell.
• Many of us have a ‘merchant temperament’. Livermore says that when a merchant has a small profit, his fingers itch to take it. He wants to keep turning over his capital. Speculators need to remember that most of winnings come from a very small number of investments, and would need to stick to winning positions.

When do we know that the market has turned?

• When all the leaders of the previous bull market fall, one can say that the market has turned.
• More importantly, he says that market does not culminate in “one grand blaze of glory”, or end with a sudden reversal. According to Livermore, markets ceases to be a bull market before prices generally begin to break. Signals such as the point made before can be used to assess this turn.

I would conclude by saying that the book is worth reading simply because many others have read it and tend to refer to it in conversations. But, it has lessons beyond simply being part of the investing language, even though the book sometimes make it hard to get to them by trying to be more of a financial history book.