Chapters V-VI

“There is what I call the behavior of a stock, actions that enable you to judge whether or not it is going to proceed in accordance with the precedents that your observation has noted. If a stock doesn’t act right don’t touch it; because, being unable to tell precisely what is wrong, you cannot tell which way it is going. No diagnosis, no prognosis. No prognosis, no profit.”

Markets are evolutionary in nature. What works today will eventually fail to work in the future. Livingston cautions the trader to be mindful of these moments. In my earlier years I used to accept general rules (i.e. heuristics) as gospel. Let’s say a descending triangle forms. The general outlook is bearish. But if price breaks down, pauses, and subsequently rallies with vigor back above the lower boundary, something is amiss. Price action fails to adhere to prior observation; thus, the diagnosis is invalid. I agree with Livingston that the best approach is to do nothing. Patience will allow the market to sort itself out and create a clear picture once again.

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“I should say that a chart helps those who can read it or rather who can assimilate what they read. The average chart reader, however, is apt to become obsessed with the notion that the dips and peaks and primary and secondary movements are all there is to stock speculation. If he pushes his confidence to its logical limit he is bound to go broke.”

A trader must understand that charts are but one piece of the puzzle – albeit a very important piece. It’s quite easy to take historical price data and generate rules that, when back-tested, show enormous paper profit. But it is the context, character, and evolution of price that one must stay abreast of. Overfit the data and end up with rules that are so inflexible a tiny change can lead to dramatic losses.

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“Not even a world war can keep the stock market from being a bull market when conditions are bullish, or a bear market when conditions are bearish. And all a man needs to know to know to make money is to appraise conditions.”

One of the simplest yet most critical observations found within Lefevre’s book. If you could develop only one skill as a trader, it would behoove you to learn this one: accurately identify the general conditions as bullish or bearish. Markets trend for years. If you don’t believe me, just look at a chart of the S&P 500 going back 50 years. Price acting unusually is always the first sign that conditions have changed. The bear market bottom of 2022 was a perfect example. Despite the 100% probability of a recession by Bloomberg at the start of 2023, markets were already well off their lows with downside momentum having completely reversed. The data was all there, but if you listened to the pundits on TV you likely did quite poorly in 2023.

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“The game of beating the market exclusively interested me from ten to three every day, and after three, the game of living my life. Don’t misunderstand me. I never allowed pleasure to interfere with business. When I lost it was because I was wrong and not because I was suffering from dissipation or excesses. There never were any shattered nerves or rum-shaken limbs to spoil my game. I couldn’t afford anything that kept me from feeling physically and mentally fit.”

It’s great to see that Livingston’s keen observation skills were not limited to financial markets. If you are not taking care of yourself, your work will suffer. There are no ifs, ands, or buts about it. The core of my personal philosophy rests on this idea. Before I approach my work, relationships, or anything else, I must have my health in good order. There are things we do that set us back in our ability to do our job well. I recognized early on that even something as simple as consuming caffeine had repercussions. Caffeine would spike my cortisol, which put me in a high-stress state, which prevented me from thinking clearly during periods of high market volatility, which led to poor trades. The solution was simple – stop drinking caffeine!

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“I never thought that something was irksome if it helped me to trade more intelligently.”

This should be true for any profession. If certain efforts lead to better results, it should motivate you. If it doesn’t, either a change in attitude or career is warranted.

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“They say you never grow poor taking profits. No, you don’t. But neither do you grow rich taking a four-point profit in a bull market”

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“Men who can be both right and sit tight are uncommon. I found it one of the hardest things to learn. But it is only after a stock operator has firmly grasped this that he can make big money… The reason is that a man may see straight and clearly and yet become impatient or doubtful when the market takes its time about doing as he figured it must do.

Livingston (i.e. Livermore) is a high-risk trader. Like me, he will plunge 100% of his capital into a single idea if he believes in it. It’s no surprise, then, that he makes these remarks. The habit of taking sure profits is what behavioral economists call loss aversion. The pain of a loss is felt significantly more than the reward from an equal gain. The individual opts for consistent, tiny profits rather than risk a paper loss. I have found those who follow these measures perpetually underperform, losing out to even the S&P despite having routinely forecasted correctly. There is also the trader who is early, who sees something must change, and positions himself accordingly. But the market can take a while to get there, and these traders inevitably bail. I have on several occasions exited my position after waiting weeks for the market to turn, only for the big move to come HOURS after I exited. This is why you do not exit while the market is figuring itself out. If it hasn’t invalidated you, sit tight.

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“If there is a solid bull foundation, for instance… certain news items fail to have the effect they would have if the Street was bearish.”

A simple measure of the strength of a bull or bear market is how it reacts to unexpected bearish or bullish news, respectively. Not only on the day of the news, but during the succeeding days as well. Take, for example, an sudden large intitutional failure some distance into a bull run. The market may sell off for fear of greater contagion. But over the next few days the market recovers from the initial sell-off and soon continues to make new highs. This is a clear example that the market is bullish, and will remain bullish, until certain conditions are met to suggest a more structural reversal.