A Trader’s True Allies: Making Millions the Livermore Way

June 1, 2012
By

Many don’t realize it, but Jesse Livermore was the original “global macro” guy.

He would trade anything back in the day — stocks, wheat, cotton, coffee, options contracts — and he surely would have traded currencies too, had the world not been on the gold standard.

Livermore, whose ideas and approaches were immortalized via Reminiscences of a Stock Operator in 1923, is widely recognized as one of the greatest traders ever… his life and times contributing to the greatest trading book of all time.

Livermore has long been one of our “mentors from afar.”

Our broad trading approach — long / short with a global macro overlay — is much modeled after his. (Along with later global macro greats who operate in the Livermore mold, such as Soros, Druckenmiller, Kovner, Bacon and Jones.)

Getting back to Livermore, it struck me how valuable the wisdom of Reminiscences has proven in this tape. Having gotten more involved on StockTwits and Twitter lately — and you should follow us if you aren’t already — it has grown apparent the great degree to which others can benefit from Livermore’s wisdom.

And by “others” I mean (ahem, cough cough) those who tried to be wiseguys this week, picking Thursday tops and bottoms in TLT and SPY, and thusly getting their heads handed to them.

Let’s go through a few classic Reminiscences quotes and see how they’ve applied to this market:

But I can tell you after the market began to go my way I felt for the first time in my life that I had allies — the strongest and truest in the world: underlying conditions. They were helping me with all their might. Perhaps they were a trifle slow at times in bringing up the reserves, but they were dependable, provided I did not get too impatient.

Being a contributor to the StockTwits and Twitter Stream, one of the things that consistently amuses and confuses yours truly is the lack of regard for underlying conditions.

Underlying conditions — also referred to by Livermore as “general conditions” — represent the flow of what is going on in the world.

Here it is again, in plain English:

I still had much to learn but I knew what to do. No more floundering, no more half-right methods. Tape reading was an important part of the game; so was beginning at the right time; so was sticking to your position. But my greatest discovery was that a man must study general conditions, to size them so as to be able to anticipate probabilities.

Underlying / general conditions encompass not just technicals — Livermore didn’t use charts, though he watched price action like a hawk — but fundamentals and sentiment too… a sense of which way the world is going and why.

Back to present day: For a macro oriented trader who pays attention to underlying conditions, it seems crystal clear which way the wind has been blowing.

In a recent piece on Gold vs Bonds, we laid out extensive drivers, along with story links, as to what was happening. Namely, the world is slowing down (as Europe slowly falls apart)…

In short, paying attention to underlying conditions can save you a lot of money — or MAKE you a lot of money — if you consistently make an effort to put the puzzle pieces together (technicals, fundamentals and sentiment) and then listen to the market’s message.

I was not pitting my tape-reading knack or my hunches against chance. The inexorable logic of events was making money for me.

Sounds damn good doesn’t it? Having “the inexorable logic of events” make money for you? As a trader, how do you do it? By studying and heeding the power of underlying conditions!!

Here’s another bit of Livermore wisdom, re, overnight gaps in the tape:

…any important piece of news given out between the closing of one market and the opening of another is usually in harmony with the line of least resistance. The trend has been established before the news is published, and in bull markets bear items are ignored and bull news exaggerated, and vice versa.

It is hard to emphasize how true this is!

And we got one hell of an example today (June 1st), with bad news from Europe, China and the US whacking markets brutally all at once. Thursday seemed to tease, and give the top-and-bottom pickers a brief minute of smugness, but then Mr. Market said NOPE…

And we were “loaded for bear” into this tape, with no long positions to speak of. Why? Because of general conditions!

Really, seriously, this stuff works. Regardless of all the whining and bitching about how hard charting has become, it works as well today as it did 100 years ago — as long as you are comfortable on both sides of the market and not just one:

I cleared about three million dollars in 1916 by being bullish as long as the bull market lasted and then by being bearish when the bear market started. As I said before, a man does not have to marry one side of the market till death do them part.

Some traders only play the bullish side, and this is a respectable approach. But we also think it’s like being a tennis player without a backhand… if you can only go long, you are going to miss half the opportunities in play, and be forced to twiddle your thumbs for interminable stretches (especially in markets like these).

Nor is this Livermore stuff just a bear market phenomenon… the “underlying conditions” logic applies in bull markets too.

Do you remember back in 2009, when markets just seemed to go higher and higher, no matter how much bears gnashed their teeth? When data point after data point from China was bullish, and everything just kept levitating?

Well, now we’ve got the opposite of that… but BOTH sets of conditions can be equally as good… as Jesse says:

They say there are two sides to everything. But there is only one side to the stock market; and it is not the bull side or the bear side, but the right side.

Amen. There is no such thing as a crystal ball, or a method of analysis that works flawlessly 100% of the time, but by golly you can get one hell of an edge by 1) getting a grasp on general conditions, and 2) applying said lessons correctly.

This stuff is SO INSANELY VALUABLE, it still blows me away that so many traders operate blindly, in shortened time frames, with no real sense of the “bigger picture” at all!

And that gets back to one of the biggest Reminiscences lessons of all:

And right here let me say one thing: After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It was always my sitting. Got that? My sitting tight!

Now here is the key thing. When Jesse talks about “sitting tight” there, he does not mean sitting tight on the sidelines waiting for the next good trade. Patience is important, of course, but that isn’t what he’s talking about.

No, the “big money” he speaks of comes from SITTING WITH BIG POSITIONS.

Getting a low risk, high quality entry on a position of meaningful size… being aligned with general conditions… and then just SITTING with that sucker — maybe even pyramiding — as it develops into a huge trade!

Not to again call out my Stocktwits brethren, but really and truly, I am partly writing this as a friendly message of encouragement and exhortation to you guys, and to all the traders I see playing for small money in small time frames, when the tape offers much greater things if they would only step back and get some vision.

The big money is NOT in nipping around for teensy little gains! (“Don’t be a dick for a tick,” as my partner likes to sometimes say.) Short-term trading can certainly be profitable… but it isn’t where the true killings, the FORTUNES, are made…

You want an inspirational example? Okay, here’s an example (click charts to enlarge):

CLICK TO ENLARGE

CLICK TO ENLARGE

This trade — which is time-stamped and still ongoing in the Mercenary Live Feed — was entered utilizing what you might call “the Livermore Method” (or what we less than modestly think of as the Mercenary method).

  • First, the Aussie was sized up in respect to general conditions — the potential for the AUDUSD carry trade to collapse, due to Australia’s resource-leveraged exposure to an overheating China. We have talked about this possiblity repeatedly in past Global Macro Notes, and publicly referred to the Aussie as a potential “trade of the year” on more than one occasion. Here’s proof
  • Second, we made multiple attempts at low risk entry based on technical confirmation — the first few getting stopped out around breakeven or for small profits, as we waited for the real move to commence. We even tweeted out a chart following the entry that stuck…
  • Third, we practiced the Livermore guideline of SITTING TIGHT on an excellent position, fully aware, via general conditions and a clear sense of valuation / macro scenarios, that this could develop into a huge trade.

Ever wonder how traders make hundreds of thousands, or even millions of dollars, on a single monster trade, with an excellent entry and strategic pyramids along the way?

How guys get into those type of positions that, in hindsight, seem like a P&L dream?

THIS IS HOW… and it isn’t “our” method, it’s Livermore’s. We just humbly apply it, on a day in and day out consistent basis, to all the markets we cover.

He laid out the blueprint, roughly 90 years ago:

  • Sizing up conditions
  • Probing for strong reward/risk entries
  • Being fully cognizant of scenarios
  • Keeping a tight rein on risk
  • Risking small, entering with size
  • SITTING TIGHT when you land a big ‘un

Of course, they can’t all be “big game” trades. We’re happy to be short-term guys too. There’s nothing wrong with ringing the cash register in a tight time frame — like, say, 3 to 5 trading days.

But if you’re stuck in tiny time frames as a rule, playing penny-ante poker and patty cake for pips, you’ve got to experience the thrill of the big kill… the hunt for big game… Jesse’s way of making the BIG money on the BIG trades.

Obligatory mention: This is what we do in the Mercenary Live Feed… with real capital, in real time… mixing trend trades, swing trades and macro trades in a blended portfolio approach. And while we have room, you’re still welcome to join us

Wondering Where the Rum’s Gone,

JS (jack@mercenarytrader.com)

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