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Book Review

How to Trade in Stocks
by Jesse Livermore
reviewed by Marco den Ouden 

Originally published in The Break Out Report - Sept. 17, 2006

Jesse Livermore was arguably the greatest stock trader who ever lived. A mathematical whiz kid, young Jesse regularly confounded his teachers with his brilliance. But his father wanted him to quit school and work the family farm so in 1891, at the age of 14, he ran away from home to Boston. There he landed a job with Paine Webber as a board marker.

With his photographic memory and mind for numbers, Jesse noticed patterns in the trading action. He discovered he could often predict where a stock was going. And so he started playing some of his earnings at the bucket shops that were popular then. These were gaming houses where you could walk in and bet on a stock with just 10% down.

These shops were a scam as the small margin and natural fluctuations in stock prices made it hard for anyone to actually make money. The operators sometimes even manipulated the market to force players out.  But Livermore, with his facility for numbers, regularly beat the bucket shops.  He  got so  good  at  it  that he was banned from them, just as a card counter is banned from Las Vegas casinos if discovered. Their blather to the contrary, the house does not like consistent winners!

From there Livermore went on to play the real stock market, slowly building up his profits. It was in 1907 that he made his first big fortune. He made $3 million shorting the market during the crash that year. He later lost that fortune and then built it back up again.

One of the things setting Livermore apart from most traders was that he was not afraid to play the short side. He had devised a set of trading rules and was supremely confident in his ability to call the market. And so he gained two of his nicknames – the boy plunger because of his boyish looks and willingness to commit a large stake to a trade, and the great bear of Wall Street, because he played the short side when circumstances warranted.

By 1929 he had made a fortune for himself, married a show girl and bought a  mansion  on  Long Island. As the great crash approached, Livermore saw it coming. He went short big time. On Black Monday, October 29th, he went home to find his wife had pulled her jewelry together for sale and moved into the chauffeur’s house. From the news on the radio she had assumed he had lost everything and would need to sell their possessions to build a new stake and start over. Livermore laughed. He had just pulled off the biggest coup of his life. He made over $100 million shorting the market. In today’s terms, that is over a billion dollars.

The fascinating tale of Livermore’s life is recounted in Richard Smitten’s biography, Jesse Livermore: World’s Greatest Stock Trader, which I reviewed in January 2002 (see review on the website) Now Richard Smitten has reissued Jesse Livermore’s own book, How to Trade in Stocks, with additional chapters by Smitten explaining and elaborating on Livermore’s ideas. It’s a fascinating read.

While the biography touched on Livermore’s techniques, this book spells them out in detail. The first seven chapters are the straight unedited Livermore tract. In it he lays out his rules for success in speculation. Livermore regarded himself primarily as a professional speculator, not an investor. He regarded the stock market as “the most uniformly fascinating game in the world.” And he treated it as a business that requires intense study and work. He had little patience for people who asked him how to make some quick money in the market.  That was akin to someone asking a doctor or lawyer how to make some quick money in surgery or law.

Livermore divided his approach into three topics: Timing, Money Management, and Emotional Control.


Livermore said that speculation “is nothing more than anticipating coming movements.” But the market is made of people, and people are emotional and not always predictable. So his first timing rule was to have patience. If you come across information that you believe will move the market or a particular stock in a certain direction, “don’t back your judgment UNTIL THE ACTION OF THE MARKET ITSELF CONFIRMS YOUR OPINION.” It is better to be a bit late in your trade and right than early and wrong.

A master of the market aphorism, Livermore wrote, “markets are never wrong – opinions often are.” You may have an opinion on a stock and even be correct in your opinion but lose money anyway if you act on your opinion too soon. Wait for market confirmation.

One of his methods was to look for stocks making new highs after a normal correction. He never bought on reactions (his term for corrections) and believed in taking a small loss if your trade goes wrong.  He was disdainful of averaging down. “Never average losses,” he admonished.

Livermore liked to look for what he called Pivotal Points. Waiting for that pivotal moment takes patience. Whenever he waited for that point, he “always made money” in his operations.

Livermore developed an elaborate method of record keeping to determine pivotal points. This method, called the Livermore Market Key, is included at the end of the book.

One of the simplest type of pivotal points, he observed is when a stock hits a milestone price of 50, 100, 200 or 300.  He notes, for example, that he bought Anaconda as soon as it hit 100. It advanced quickly to 150 and continued. When it reached 200 he bought some more. The stock still climbed. At 300 he again bought some more. But then it only climbed to 302 ¾. This he regarded as a danger signal and he sold everything. A few days later the stock was back to 225. “The action of Anaconda, after crossing 300,” he writes, “was entirely different than its action above 100 and 200.”

Stocks, Livermore said, have personalities like people. “Some are high-strung, nervous and jumpy – others are forthright, direct, logical.” Small reactions and rallies in a stock are normal. A stock never stands still. It always moves a little bit. It is when a stock starts to behave abnormally that one should be wary. If you are invested in a stock and it has an abnormal reaction, that is, a drop much greater than usual, “it is flashing you a danger signal which must not be ignored.” Or, as noted above, when it fails to advance as anticipated, that is also a danger signal.

Because his method of determining pivotal points by keeping elaborate records is a bit complicated, I cover it in a separate sidebar.  It is worth the effort, he says. “The results are almost beyond belief.”

The essence of Livermore’s approach can be summarized as taking the line of least resistance. Wait for a stock to establish a definite direction and then go with the flow until a reversal pivotal point is reached. “Be ever vigilant for the danger signs” that mark such reversals.

Money Management

The money management aspect of Livermore’s approach is better explained in Smitten’s chapters which quote extensively from Livermore’s writings. Livermore had five rules for money management.

  1. Don’t lose money. Do this by probing your positions rather than establishing your full line at once.

If Livermore was planning to buy 1000 shares of a stock, he would probe first by buying 200 shares. If it rose he would buy 200 more. If it continued to rise he would buy another 200. And if it continued to rise, or underwent a minor correction and then rose again, he would buy the last 400.

“The basic logic is simple and concise,” said Livermore, “each trade, as it is established toward the total 1000 share position, must always show the speculator a profit on his prior trades.”

This is tough for most people, said Livermore, because “it goes against human nature to pay more for each trade.”

While Livermore used a 20, 20, 20, 40  approach, he says each individual trader should choose an approach that suits him, perhaps 30, 30, 40 or whatever.

  1. Never sustain a loss of more than 10% of invested capital.  In other words, use stop losses to protect your downside. A trader’s capital is like a shop keeper’s inventory. Don’t lose it! “Take your losses quickly,” says Livermore. “Easy to say – hard to do!”
  2. Keep cash in reserve.  Livermore says you should resist the temptation to be in the market all the time.  Again, patience is a virtue and waiting for the right opportunity is better than being foolishly invested.  There are times when you should be 100% in cash.

Smitten starts the book with a marvelous story to illustrate this point. Livermore always sold out all his positions at the end of every year and had the cash deposited in his account at the Chase Manhattan Bank. Then he would arrange with the bank to have the money, in cash, in the bank’s vault in chests. “There was a desk, a chair, a cot and an easy chair in the middle of the cash.” On the occasion described in 1923, there was $50 million in cash.  In the corner was a fridge with food, enough for a few days. There was lighting installed. Then, like Scrooge McDuck, Livermore would have himself locked in the vault with his cash. He would stay a couple of days and “review his year from every aspect.” 

After his stay was over, he would fill his pockets with cash and go on a shopping spree.   He would also take  a vacation and not re-enter the market until February.

But unlike Scrooge McDuck, this was not the act of a miser, explains Smitten.  Livermore lived a world of paper transactions all year long. He believed that “by the end of the year he had lost his perception of what the paper slips really represented, cash money and ultimately power.”  He “needed to touch the money and feel the power of cash.” It made him re-appraise his stock and commodity positions.

  1. “Stick with the winners as long as the stock is acting right – do not be in a hurry to take a profit.  If there are no negatives or warning signals, let your winners ride!

Livermore had the opinion that if he was in a profitable position, he was playing with the stock market’s money and if he lost it all, then he “lost money (he) never had in the first place.”  And the opposite also held, if a trade went against him right away, he sold out quickly. Aphoristically, he put it this way: “Profits take care of themselves – losses never do.” But, he cautioned, do not confuse this with the buy and hold forever approach. Keep an eye out for the danger signals that herald a reversal pivotal point.

  1. “Park 50% of your profits from a successful trade, especially where you doubled your original capital. Put it in the bank, hold it in reserve.”  This, in fact, is the rule Livermore regretted not paying enough attention to. He went broke a number of times from not following his rules.

Smitten also lists a number of other Livermore principles in this section, such as:

    • Avoid cheap stocks
    • Disregard the action of insiders
    • Stick to the strongest industries and the strongest stocks in those industries

Jesse Livermore


Emotional Control

Livermore was one of the first students of market psychology. He observed that the market is moved by fear, greed and hope.  The average investor is fraught with fear when he loses money and this clouds his judgment. “And the unsuccessful investor is best friends with hope,” he said. But hope, like fear and greed, distort reason. “The market,” he told his sons, “only deals in facts, in reality, in reason, and the stock market is never wrong – traders are wrong. The result is objective and final, with no appeal, like pure nature.”

For the most part, Livermore followed the “line of least resistance”. “The trend is your friend,” he said. The trick is to “separate (yourself) from the popular thinking,  the group thinking and go in the opposite direction” when evidence of a change in trend appears. As he put it, “these major changes in trends were hell. But, I did not want to toboggan downhill with the crowd, unless I had sold stocks short.” 

To counter the emotional roller coaster, Livermore had two rules:

  • Do not be invested all the time. There are times when it is better to be 100% in cash, “especially when I was unsure of the direction of the market.”
  • Use small position probes to test whether your prediction of a change in market trend is correct.

I’ve covered a lot of what is in the book in this review but there is much more and I highly recommend buying it and reading it through – several times! 


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