Reminiscences of a Stock Operator

Edwin Lefèvre · 1923

Thesis

Speculation succeeds not through cleverness or information but through character: reading what the market is actually doing, waiting for the big movements, cutting losses quickly, adding only to positions that are working and refusing other people's tips, because the market's patterns repeat as long as human nature does not change.

The main ideas

There is nothing new on Wall Street. Speculation is as old as the hills, because human nature does not change.
The big money is made in the main movements, not the daily fluctuations, and by sitting tight rather than by thinking.
Prices move along the line of least resistance. Trade with it, not against it.
Cut losses at once and never average down. Keep what shows a profit and sell what shows a loss.
Tips, inside information and other people's opinions are the speculator's greatest danger.
Even the best speculator is ruined by abandoning his own rules.

Nothing new on Wall Street

Edwin Lefèvre's book, serialized in the Saturday Evening Post in 1922 and 1923 and published as a book in 1923, is told in the first person by a speculator called Larry Livingston, a thinly fictionalized Jesse Livermore. Its first lesson comes in the opening chapter: there is nothing new in Wall Street, and there cannot be, because speculation is as old as the hills.

Livingston's point is that markets are driven by hope, fear and greed, and these do not change. A trader who learns how prices behaved in one boom or panic has learned how they will behave in the next, because the people buying and selling are the same kind of people.

His education begins as a boy chalking up prices in a brokerage office, where he learns to see patterns in the numbers. He takes that skill to the bucket shops, gambling parlors where customers bet on price changes without any shares changing hands, and beats them so consistently that he is barred from them, including the Cosmopolitan, the richest bucket shop in New England.

Implication: study the history of booms and panics. The details differ, but the behavior that drives them repeats.

The big money is in the big moves

The book's central lesson comes from an old trader called Partridge, who answers every request for advice with some version of the same remark: this is a bull market, you know. Livingston comes to see that Partridge meant the big money was not in the individual fluctuations but in the main movements, in sitting on a position through a long trend instead of trading in and out of it.

He later puts it in his own words: it never was his thinking that made the big money, it was his sitting. Many traders are right early; few hold their positions long enough to collect.

Prices, he argues, move along the line of least resistance. A trader should wait until the market shows which way that line runs, then trade in its direction, adding to the position as the market confirms it. But he qualifies the practice of pyramiding: a speculator ought not to buy a full position all at once, and should add only as the trade proves itself, not persistently and regardless of what the market is doing.

Implication: once a position is clearly working, the hardest and most important task is to keep it. Let the market's direction, not the urge to act, decide when to trade.

Cut losses, never average down

Livingston's rules on losses are absolute. "Of all speculative blunders there are few greater than trying to average a losing game." Adding to a losing position in the hope of recovering throws good money after bad. His positive rule is the mirror image: always sell what shows a loss and keep what shows a profit.

Most people do the opposite. They take small profits quickly, for the pleasure of being right, and hold losses in the hope of being proved right later. Livingston argues that a loss never hurt him once he took it; what did the damage was being wrong and not taking the loss.

The mechanism is psychological. Hope keeps a trader in a losing position, and fear pushes him out of a winning one; both lead to small gains and large losses.

Implication: decide in advance the point at which a position is wrong, sell when it is reached, and resist the urge to take profits early on positions that are working.

Other people's judgment

The book's costliest episodes come from abandoning his own judgment. In one, a respected cotton trader named Percy Thomas persuades Livingston to buy cotton against his own reading of the market. He holds a huge losing cotton position, about 440,000 bales, while selling a winning wheat position too early, and the episode wipes out nearly all he has. The lesson he draws is that a speculator must trade only on his own judgment, however eminent the person advising otherwise.

His successes come from the opposite. He sells Union Pacific short on his own reading of the market shortly before the 1906 San Francisco earthquake, though he admits luck played a part. In the panic of 1907 he makes a fortune shorting the falling market, then, at the request of leading bankers trying to stop the panic, covers his shorts and buys.

The mechanism is that tips and advice substitute someone else's reasons for your own, so you cannot know when those reasons have stopped applying.

Implication: do not act on tips, however reliable their source seems. A position you cannot explain in your own terms is one you will not know how to manage.

Corners, manipulation and ruin

The later chapters turn to the larger game of corners and manipulation. Livingston corners the July cotton market and makes a million-dollar day. He takes a loss on a corn position when a Chicago operator named Stratton corners corn. During the First World War he goes long coffee, and coffee roasters complain to the government's Price Fixing Committee that he has cornered it; the price is fixed, and he makes no profit.

He also describes his bankruptcies. At one point he owes more than a million dollars, obtains releases from most of his creditors and later repays all of them in full, the last being a creditor owed $800 who had pestered him the most.

The mechanism the book shows is that the same speculator who wins by following rules loses by breaking them, through overconfidence, outside advice or forcing trades when the market offers nothing.

Implication: expect your own success to tempt you into larger, looser bets. The rules matter most just after they have made you rich.

Limits

The book's hero did not follow his own lessons to the end. Jesse Livermore filed for bankruptcy again in 1934, listing about $2.26 million in liabilities against $184,000 in assets, and died by suicide in 1940, leaving a note that called himself a failure.
It is fiction based on fact, and the line between them is unclear. The last five chapters draw heavily on a separate series of articles Lefèvre wrote on manipulation, and annotated editions have had to reconstruct which events and people are real.
The market it describes is gone. Bucket shops were outlawed and had largely disappeared by the 1920s, and the Securities Exchange Act of 1934 made the manipulation the later chapters describe illegal.

Market Wizards + The New Market Wizards + Stock Market Wizards + Hedge Fund Market Wizards + Unknown Market Wizards + Market Wizards: The Next Generation — modern traders interviewed on the same rules: cut losses, trade your own judgment, sit with winners.
Fooled by Randomness — a warning against reading one trader's success as proof that his rules work.
Devil Take the Hindmost — the history of the booms and panics in which speculators like Livingston operated.