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Legacy of the Legendary Trader Jesse Livermore

Posted on by Michael Covel

Jesse Livermore was an outstanding trader. The insights he shared with the world are invaluable. Josh Brown wrote a great article featured on www.ritholtz.com pointing out some of his great nuggets of wisdom as well as how he would react in this day and age with news outlets streaming 24/7:

There are those who would convince you that it is somehow smart or in your best interest to be manically switching your investments around, back and forth, long and short, on a daily basis. To pay attention to this kind of overstimulation is the height of madness, even for professional traders.

The most storied and important trader who ever lived, Jesse Livermore, would be tuning these daily buy and sell calls out were he alive and operating today. Because while he was a trader, he was not of the mindset that there was always some kind of action to be taking.

Jesse Livermore’s legacy is a bit of a double-edged sword…

On the one hand, he was the first to codify the ancient language of supply and demand that is every bit as relevant 100 years later as it was when he first relayed it to biographer Edwin Lefèvre. Livermore himself sums it up thusly: “I learned early that there is nothing new in Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again. I’ve never forgotten that.”

On the other hand, Livermore’s undoing came at precisely the moments in which he ignored his own advice. After repeated admonitions about tipsters, for example, Jesse allowed a tip on cotton to lead to a massive loss which grew even larger as he sat on it – violating yet another of his own cardinal rules.

And of course, other than for a few moments of temporary triumph in the trading pits and bucket shops of the era, Jesse Livermore was not a happy man. “Things haven’t gone well with me,” he informed one of his many wives by handwritten note, before putting a bullet through his own head in the cloakroom of the Sherry-Netherland Hotel.

But he did leave behind a wealth of knowledge about the art of speculation. His exploits (and cautionary tales of woe) have educated, influenced and inspired every generation of trader since Reminiscences was first published in 1923.

In my opinion, some of the most useful bits of knowledge we get from the book concern Jesse’s discussion of timeframes and patience. Many traders, particularly rookies, approach the game with the idea that they’re supposed to be constantly doing something – in and out, with a trembling finger poised to click the mouse again and again. Consequently, they get on the treadmill of booking wins and losses without ever really moving the needle. They end up with tons of brokerage commissions and taxes to show for their efforts, but not much else.

Being a trader doesn’t mean one must always be executing a trade, just as being a house painter doesn’t mean that every surface needs an endless series of coats.

Many rookies are surprised to learn that Livermore, the idol of so many great traders, advocated a lower maintenance, higher patience approach as he matured. In his early days, Livermore was dependent on the short-term funding and scalping activity of the bucket shops. Once he graduated and had his own capital, he was able to lengthen position holding times and could even afford to do nothing for extended periods.

Here are nine surprising things Jesse Livermore said regarding excessive trading:

  • “Money is made by sitting, not trading.”
  • “It takes time to make money.”
  • “It was never my thinking that made the big money for me, it always was sitting.”
  • “Nobody can catch all the fluctuations.”
  • “The desire for constant action irrespective of underlying conditions is responsible for many losses in Wall Street even among the professionals, who feel that they must take home some money everyday, as though they were working for regular wages.”
  • “Buy right, sit tight.”
  • “Men who can both be right and sit tight are uncommon.”
  • “Don’t give me timing, give me time.”

and finally, the most important thing: “There is a time for all things, but I didn’t know it. And that is precisely what beats so many men in Wall Street who are very far from being in the main sucker class. There is the plain fool, who does the wrong thing at all times everywhere, but there is the Wall Street fool, who thinks he must trade all the time. Not many can always have adequate reasons for buying and selling stocks daily – or sufficient knowledge to make his play an intelligent play.”

Jesse was a trader but he knew the value of staying with positions and sometimes not trading at all. Once he began to follow tips from others or trade when he should have abstained, all of his progress had come undone, and with it, his sanity.

We are fortunate to be able to learn from his mistakes and to sidestep the errors that eventually cost him everything.

Jesse Livermore Books:

• How to Trade in Stocks (PDF)
• Reminiscences of a Stock Operator (PDF)

Recommended Trend Following Posts and Podcasts

Twenty Eight Years On Wall Street

Trend Following Wisdom of Jesse Livermore

Reminiscences of a Stockbroker

Bitcoin Trend Following

On Holding

Striving for Excellence

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Go Zen With the Markets

Posted on by Michael Covel

A little Zen can go a long way in the markets:

You. Right. Again. http://blogs.hbr.org/2014/01/a-little-meditating-helps-you-make-better-business-decisions/

Gary

Thanks. Excerpt from the research:

Research participants who had spent just 15 minutes in “mindfulness” meditation, focusing on their breathing, were 77% more likely than others to resist what’s known as the “sunk-cost bias,” the tendency to stick with a less-than-optimal strategy merely because a lot of money has been sunk into it, says a team led by Andrew C. Hafenbrack of Insead business school in France. In a fictional scenario, the participants had to decide whether to buy a highly efficient $10,000 machine shortly after spending $200,000 on equipment that was much less efficient (and couldn’t be sold). Meditation’s impact on the sunk-cost bias may have to do with its ability to improve mood and decrease people’s focus on the future and past, the researchers suggest.

Source: Go.

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The High Priests of Finance

Posted on by Michael Covel

Courtesy of The Economist:

Finance even has its own high priests in the form of the analysts and fund managers who promise their clients heavenly rewards if only they listen to their advice. They preach regular sermons in the form of brokers’ notes and quarterly reports, and they house themselves in vast cathedral-like buildings that dominate the skyline. Each day also has its canonical hours as traders pray for profitable opportunities at the European, American and Asian market openings. Finance has its annual calendar, too, marked with festivals known as results seasons in which the lucky participants receive their temporal (rather than spiritual) dividends.

And like any self-respecting religion, finance has its doctrinal schisms as well. Active fund managers are a bit like the medieval Catholic church, offering eternal salvation to those willing to pay the appropriate sum, which are known in modern parlance as performance fees rather than indulgences. The active-investment sect has its elaborate rituals and language, with a liturgy (“information ratios” and “alpha generation”) as baffling to the layman as the Latin mass was to the medieval peasant. Clients are supposed to listen to their presentations in a reverential hush, trusting that all the mumbo-jumbo will deliver superior results. The passive fund managers, or index-trackers, are akin to early Lutherans. Investors have no need for priestly intermediaries between them and the market, say the index-trackers. All they require is the full text of those companies that are included in the benchmark.

Finance also has its equivalent of holy men, the gurus who pronounce on the market outlook. Not for nothing is Warren Buffett known as the “sage of Omaha”. The faithful conduct an annual pilgrimage to Nebraska every year to attend the annual meeting of his company, Berkshire Hathaway. His folksy demeanour would surely make him the ideal neighbourhood priest, bringing comfort through life’s ups and downs.

Nice.

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Greenspan Wakes Up to Behavior

Posted on by Michael Covel

From The Wall Street Journal:

“I’ve always considered myself more of a mathematician than a psychologist,” says Mr. Greenspan. But after the Fed’s model failed to predict the financial crisis, he realized that there is more to forecasting than numbers. “It all fell apart, in the sense that not a single major forecaster of note or institution caught it,” he says. “The Federal Reserve has got the most elaborate econometric model, which incorporates all the newfangled models of how the world works—and it missed it completely.” He says JP Morgan had put out a forecast three days before the crisis saying the economy was on the rise. And as late as 2007, the International Monetary Fund also said that global risk was declining. “A few days [after the crisis hit], I run into an article, and it is titled, ‘Do we economists know anything?’ ” he says.

Mr. Greenspan set out to find his blind spot step by step. First he drew the conclusion that the nonfinancial sector of the economy had been healthy. The problem lay in finance, because of its vulnerability to spells of euphoria and irrational fear. Studying the results of herd behavior provided him with some surprises. “I was actually flabbergasted,” he says. “It upended my view of how the world works.”

He concluded that fear has at least three times the effect of euphoria in producing market gyrations. “I wouldn’t have dared write anything like that before,” he says.

Studying the minutiae of the events leading to the financial crisis brought to mind some lessons from his famous friendship, from the 1950s on, with the late Objectivist philosopher Ayn Rand. He says that Rand didn’t influence him politically—he was always a libertarian—but she did point out tensions in his philosophy about life. “She caught me in contradictions, which shook me, and I said, ‘My God, she is right,’ ” he says.

Mr. Greenspan then believed in analysis based mainly on hard science and empirical facts. Rand told him that unless he considered human nature and its irrational side, he would “miss a very large part of how human beings behaved.” At the time they weren’t discussing economics, but today he realizes the full impact of emotions and instincts on markets. He also has come to admire psychologist and Princeton University professor emeritus Daniel Kahneman’s work applying psychological insights to economic theory, for which he won a Nobel Prize in 2002.

Good for Greenspan. So late to the party.

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Momentum is Everywhere…

Posted on by Michael Covel

Recent article on momentum:

***

There is a vast body of evidence demonstrating that stock returns exhibit momentum — that is, stocks that have done well over the past year tend to continue to do well. And there’s evidence that the momentum premium exists almost everywhere we look, in both U.S. and international stocks (with the notable exception of Japan). There’s also academic research demonstrating that momentum exists in commodity and foreign exchange markets as well. The authors of the 2012 paper, “Momentum in Government-Bond Markets,” studied the period 1987-2011 to determine if momentum existed in these assets. For six countries — Australia, Canada, Germany, Japan, the U.K., and the U.S — they formed long-short portfolios, going long a particular bond maturity if the excess return of the bonds over cash was positive for the previous month and shorting otherwise. For each country they considered three maturity buckets: 1-3 years, 5-7 years and 7-10 years. They subtracted the LIBOR cash return to arrive at the “excess” return. Rebalancing was done monthly. The strategy is easily implementable using highly liquid futures markets. The benchmark is the currency-hedged Citigroup World Government Bond Index. The following is a summary of their findings:

  • Momentum strategies are profitable, generating annual excess returns over LIBOR of between 0.70 and 2.6 percent, and they do so with low volatility (1 percent to 3.6 percent).
  • Australia, with the least liquid of the six markets studied, exhibited the lowest returns to momentum strategies. The three most liquid markets — U.S., Japan and Germany –are the best for momentum strategies. Thus, greater liquidity doesn’t seem detrimental to momentum strategies (and trading costs are the lowest in the most liquid markets).
  • The strategy doesn’t rely on falling interest rates. However, “choppy” markets without direction are detrimental to performance, and returns can be episodic.
  • The excess profits generated are more than sufficient to cover transactions costs as the government bond markets are very liquid.
  • Momentum returns are particularly strong during periods of poor performance for credit markets. Thus, momentum strategies provide some diversification benefit against bond strategies that seek exposure to credit (default) risk.

The authors tested the diversification benefits by combining a 20 percent momentum strategy with an 80 percent Barclays Capital U.S. Aggregate Bond Index allocation, with monthly rebalancing. The simulated portfolio generated excess returns of 0.35 percent a year while reducing volatility — the standard deviation fell 0.40 percent. Investors who take credit risk in their bond allocations should consider adding a momentum strategy. This diversification benefited provided by momentum strategies also applies to investors in value stocks. Because momentum is negatively correlated with the value premium, adding momentum to a value-tilted portfolio improves risk-adjusted returns. While there is a logical risk-based explanation for the existence of the stock, small-cap and value-stock premiums, there is none for momentum — only a behavioral story. Yet, despite the fact that there is no risk-based explanation and that the existence of momentum has been known for decades (thus it would seem that it should have been arbitraged away), momentum persists virtually everywhere we look.

***

Otherwise known as trend following.

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Cold Truth About Emotional Investing

Posted on by Michael Covel

Consider an excerpt:

WSJ: What do you mean by emotional finance?

PROF. TUCKETT: What we try to do in emotional finance is start with the fact that the future is unknowable. The key thing about uncertainty is that it inevitably generates feelings. Because it matters to you, because your money’s on the line, so to speak, you’re bound to feel emotionally engaged.

WSJ: Some people think pros are more rational than individual investors.

PROF. TAFFLER: Although most of the fund managers we interviewed saw part of their particular competitive advantage as remaining, as they described it, unemotional or rational, in practice they were just as emotional as anyone else when they started to talk about the stocks they had invested in. There were lots of examples where they referred to them almost as if they were lovers.

If you’re entering into an emotional relationship with a stock, an asset or a company that can let you down, this leads to anxiety, which is often not consciously acknowledged. But it’s there, bubbling beneath the surface.

WSJ: The fund managers told stories about their investments. What was the role you found that storytelling played in their decision making?

PROF. TUCKETT: They have to feel conviction. With a narrative you can join up different facts with emotions, and that creates a sense of conviction, and that is absolutely essential for action. So we aren’t saying “Oh, they’re only storytellers.” We’re saying you need to tell a story.

PROF. TAFFLER: One of the fund managers talked about investing in a fast-food company, how he visited the restaurants and looked at what people were ordering. The story was about seeing something nobody else could see, and that feeling gave him the confidence to invest.

WSJ: Could you talk about what investors expect from fund managers and what effect that has on the fund managers?

PROF. TAFFLER: A very important insight in emotional finance is the concept of the fantastic object. It’s like Aladdin’s lamp, which you polish and can have anything you want. In unconscious terms this is ultimately what we are all looking for.

The whole environment is problematic, because fund managers are expected to outperform on a continuous basis, in competition with other equally able and well-resourced managers, and of course not everyone can do this. So actually the fund managers are required to be fantastic objects, to earn continuous superior returns at low risk. This is, of course, only possible in fantasy, not reality.

To be able to do this, fund managers have to be able to believe they can find fantastic objects themselves, stocks with which they can have special relationships and which are going to outperform with minimal risk.

WSJ: With individual investors, I suppose it’s about managing the uncertainty of putting their money into the markets—it helps if they’ve got this idea of the star manager who can handle it all for them.

PROF. TAFFLER: Yes. In emotional-finance terms an important part of the fund manager’s job is to defeat uncertainty. In a sense we’ve got an institutional structure which seeks to deny that ultimately we’re all working in an environment that is inherently unpredictable.

WSJ: What can individual investors learn from your research?

PROF. TAFFLER: I’ve done separate research on individual investors, and of course they have all these same feelings writ large. You need to recognize that cognition and emotion go together; you can’t have one without the other. If you were coldly unemotional, which is of course not possible, then you wouldn’t actually be able to generate the conviction necessary to take the risk of investing.

Sums up many reasons why trend following excels.

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The Journey of Turtle Trader Liz Cheval Took to Make Her Fortune

Posted on by Michael Covel

From Attain Capital Management:

In many ways, it can all come down to one decision- one choice in one moment that crystallizes a path in front of you. That path is rarely straight and often difficult to navigate, but once that moment has come and gone, the rest- as they say- is history. For Liz Cheval, chairwoman of the close to $150 million managed futures program EMC, that decision was the choice to respond to Richard Dennis’ famed turtle trader ad.

The story of the turtle traders [see my book The Complete TurtleTrader for more] is pretty fantastic in and of itself. Two renowned traders disagree. One says that what they do is unique, while another says that he could train anyone to trade. They make a wager on the issue, an ad is placed in the paper, and the lives of 20 students would never be the same. As the only female selected for the program, Cheval’s life was turned upside down.

After receiving a degree in mathematics from Lawrence University in Appleton, Wisconsin, Ms. Cheval was working as a trade clerk at the Chicago Board of Trade when Mr. Dennis placed his ad in the paper. At the time, women were few and far between in the famed Chicago trading pits. To hear her explain it, it was largely a function of physique.

“When I started on the floor of the CBOT in the early 1980’s… It was difficult for women to compete, given the physical demands of pit trading and the advantages of a larger, heavier frame,” she recalls.

It was on the floor that Cheval found herself drawn to Dennis’ offer. The excitement in the pits over the opportunity was palpable, as resumes were quickly refreshed and rushed to the mail. Cheval found herself being pushed to apply as well, even by those competing against her for a slot (including her employer). When called into an interview, she began to think that maybe she was missing something.

“As I approached the interview, I thought the opportunity with C&D was literally too good to be true,” she explains. “I simply couldn’t believe that a world renowned trader would teach us his methods and give us his private capital to trade. I assumed that there would be a catch, another story revealed at the interview.”

It turned out that the interview was simply the opportunity of the lifetime.

“It was not until the end of the interview, as Mr. Dennis’ top executive explained the nature and the details of the program that I began to believe it was the real deal,” Cheval recounts. “At that point, I became overwhelmed. My throat went dry. My legs were shaking. I could barely walk out of the room. If I understood the true nature of the program at the beginning, I would not have been as collected during the interview and would not have been selected. ”

Being selected may have been the easy part. After the interview began a rigorous amount of training, and the competition was fierce.

“The group was extremely competitive. The dynamic was open, above-board and collegial, but no doubt, everybody wanted to win,” Cheval states.

Even as the only woman in the group, Cheval found herself seamlessly blending into the adrenaline fueled atmosphere. The experience, by and large, was a positive one. She was able to earn the respect of her peers, and believes that working in a group of professional, competitive men helped prime her for professional challenges in the future.

When the training was done, it was time to hit the pavement running. The turtles were hungry to spread their wings and test their mettle. Cheval remembers making phone calls upon completion of the program, trying to gauge the level of interest for outside investors. That former employer who had encouraged her to apply? He became EMC’s first client, investing $1 million.

While it certainly has not been a bed of roses, Cheval has done very well for herself. EMC , which she runs with former turtle Brian Proctor, now has $148.75 million in assets under management, and is as well respected in the industry as you can get, in our opinion. She credits the nuanced strategies involved in managed futures with keeping her in the game. Even with this success, Cheval knows that you need to keep pushing to make it in this industry.

“The ability to adapt to change is the key to long term success in trading. It’s relatively easy to develop a profitable trading strategy over a short time frame. It’s far more challenging to develop a reliable method to continually adapt the strategy to future market conditions,” Cheval states.

Adaptation is especially important in an environment like what is seen today. Managed futures seems to be perpetually under attack by mainstream media pundits and financial advisors, with the bulk of comment being directed toward “greedy speculators.” This misconception, paired with investor frustration over a divergent return stream and increasing government intervention in the markets, can complicate the managed futures conversation, but Cheval is up to the task. In her mind, the theory of the game makes the challenge all the more worthwhile.

Her experience in the industry has granted her a great deal of perspective, and she’s more than willing to share it. The secret to becoming a successful CTA? She’s not keeping mum.

“You need both a successful trading strategy and, more importantly, a reliable method to adapt the strategy to future market conditions. A successful trading strategy requires robust systems and sound risk management principles. The trading strategy is only as good as your research process. You have to identify robust estimators and develop a process to continually adapt the systems based on these reliable estimators,” Cheval says. “You have to be disciplined in executing both trading and research strategies, in good periods and bad. A CTA has to be committed to their strategy whether it is in or out of favor.”

And for all you women out there thinking about entering the field?

“Over the years I encouraged women to manage money because I believed it to be a gender neutral occupation. No one can dispute your contribution based on gender in investment management. Your performance is there in black and white in the P&L report,” states Cheval.

“Go for it. Today the physical advantage of men [in the trading pits] is inconsequential because trading is virtually 100% electronic. I give the same advice to both men and women seeking entry level jobs in managed futures. Technical skills are mandatory. Great thinkers and idea creators need technical applications to test and execute trading strategies. Having those skills is a great way to gain entry or to build your own business.”

However, in our conversations with Cheval, it was her comments on the future of the industry that resonated with us most.

“Money centers will shift, performance will change, but overall, global markets are large and expansive,” she quipped. “Markets and managers will adapt.”

We couldn’t agree more.

Unfortunately, Liz Cheval recently passed away, but her success lives on.

Related Podcasts and Articles:

Trend Following Forward by Charles Faulkner

Lobster Logic

Interview with Brennan Dunn

Learning Trading Mechanics

Trend Follower Cliff Asness

How can you move forward immediately to Trend Following profits? My books and my Flagship Course and Systems are trusted options by clients in 70+ countries.

Also jump in:

• Trend Following Podcast Guests
• Frequently Asked Questions
• Performance
• Research
• Markets to Trade
• Crisis Times
• Trading Technology
• About Us

Trend Following is for beginners, students and pros in all countries. This is not day trading 5-minute bars, prediction or analyzing fundamentals–it’s Trend Following.