Money Management - From the World’s Greatest Trader
Jesse Livermore is regarded by many on Wall Street as the world’s greatest trader. He started from zero, and made up to $100 million in the 1929 stock market crash.
He had an interesting approach to money management which helped to maximise his profits, whilst minimising the inevitable losses. This article discusses how he did this, and how you can use his insight in your own trading.
His first principle was to never add your entire position at once. Livermore called this his probe system. For example, if he wanted to purchase one million shares, he wouldn’t just buy that number at once. He might purchase 20,000 to see if the market moved in the direction he expected it to. If it did, he would add perhaps another 100,000 at the higher price. Then he might purchase some more, and then finally purchase the last 500,000. For each purchase, the price would have to keep increasing. Livermore would never average down a losing position.
The reason for this is that it allows the market to confirm that the basic logic of the trade is correct. This isn’t an easy approach because it involves buying at higher and higher prices. Human nature loves a bargain, but if the price suddenly fell away, Livermore’s approach would save him from using up his entire capital in a losing trade.
His second principle was to limit his losses. Jesse Livermore would never risk more than 10 percent of his capital on a trade. If you risk 50% of your capital, and lose it, you need to make a lot more to recover the money. Your chance of ruin increases as you increase the amount you will risk per trade. Livermore would determine his stop loss point before making a trade.
Even if the 10% loss point was not reached, Livermore would close a trade if the stock was not performing as he expected it to.
Livermore also made it one of his principles to keep cash in reserve. This allowed him to use the money at the critical moment to take advantage of opportunities.
When he had a significant windfall, he took out 50% of the money and set it aside. He also purchased significant annuities to ensure that he was never without a trading stake, irrespective of how he went. If someone continually reinvests all their cash, they are not keeping reserves out of the market.
Jesse Livermore used some simple principles to ensure trading success, but he didn’t always follow them. Breaking his own rules eventually caused his downfall, and unfortunately he shot himself in 1940. However, the rules are sound. The rule about averaging into a winning position is particularly good advice.
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Loading ...Tags: Jesse Livermore, money management, pyramiding, stop losses
April 16th, 2008 at 2:00 pm
I recently came accross your blog and have been reading along. I thought I would leave my first comment. I dont know what to say except that I have enjoyed reading. Nice blog.
Tim Ramsey