Trade Stocks Like Jesse Livermore

One of the greatest things that I have learned by reading books about Jesse Livermore regards easing into a stock position. Jesse Livermore is arguably the greatest stock speculator in history. He had a gift for numbers and identifying patterns in the ticker tape that allowed him to profit handsomely whether he was long or short a stock.

A brilliant technique that he used was to ease into your stock positions. What this means is to figure out your total exposure to a stock and divide that into 4 or 5 portions. Then when you feel that it is time to invest, take that initial 20% position and see what happens. He would call these initial positions probes. If the stock goes against your position (long or short), then you can sell and get out based upon your risk tolerance. If the stock moves in the direction that you expect, then you can add the next portion so that you are adding from a profitable position. It turns out that this is just the opposite of averaging down which can ultimately get you into serious trouble if the company goes bankrupt.

Assume you have $20,000 that you would like to invest in Yamana Gold (AUY) which closed today at $10.72. You would then purchase about 400 shares at $10.72 and wait to see what happens. If the stock drops under $10, you decide that you sell. Even though that represents an almost 7% drop in the stock, your actual loss is only $288 on the 400 shares which is only 1.4% of your total capital.

Then you can either move on to a better idea or keep watching AUY with the majority of your capital intact. If you watch and really like AUY when it gets to 6, this time around, you could pick up 650 shares for the same 20% of your available capital. As the stock rebounds to 8, you can invest the next 20% of your capital purchasing about 500 shares. You end up with more shares at the cheaper price which brings your cost basis down more than you might expect. You decide to sell again because it drops to $7.25.

1. Start with $20,000 capital

2. Purchase 400 shares at $10.72 for $4,288

3. Sell at 10 taking your loss of $288 in a disciplined fashion

4. Capital left is $19,712

5. Purchase 650 shares at $6 for $3,900

6. Purchase 500 shares at $8 for $4,000

7. Sell 1,150 shares at $7.25 for $8,337.50 because you are disciplined

8. End with $20,149.50 despite favoring a stock that declined from $10.72 to $7.25 while you were interested in it

As you can see, you don't always have to be right in your stock picks to make money in the market.  Often times the key is protecting your capital, being patient, and managing your money appropriately.

You may have noticed that I emphasized the word discipline in the above example.  Much like golf, a large part of successful investment is mental and emotional.  After hitting a poor shot in golf, the goal becomes not to make a heroic shot but to minimize the damage and move on to the next hole.  The same holds true for investing.  When you make a mistake by picking the wrong stock, performing incomplete fundamental or technical analysis, or getting swept up in the general market trend, the key becomes not allowing the mistake to compound upon itself.

In investing you must be disciplined enough to take a loss and move on.  I have been investing for 10 years, and I am just getting to the point of understanding and being able to implement this.  This is what I mean by being disciplined.  Easing into your stock positions is a way to minimize your losses.  I cannot stress enough the importance of keeping as much of your capital intact.  Losing half your capital is like trying to run a marathon after losing half your blood volume.  It is just impossible to keep up. 

I hope you have learned something from this information.  Remember don't be afraid to take a loss.  Be disciplined!