Jesse Livermore wrote:
“Analyze in your own mind the effect, marketwise, that a certain piece of news may have… Try to anticipate the psychological effect of this particular item on the market. If you believe it’s likely to have a definite bullish or bearish effect, don’t back your judgement UNTIL THE ACTION OF THE MARKET ITSELF CONFIRMS YOUR OPINION.”
How can we apply Jesse’s thoughts in today’s markets?
When looking for trades, two questions to ask are:
- Is there a good underlying story to engage the interest of other investors or traders?
- Can I see the potential for a big price move?
The two issues are, more often than not, related.
After the market has “given its approval” for a trade, you may buy into the early stages of a trend, hoping that the trend will be solid enough to last for months – or even years. You can also hope the slope of the trend will be rewarding. If the slope is too shallow, you might ride the trend successfully, but make less money than if you’d picked a better trend.
The “story” behind the trade is an important one – because if the story is good enough, it can carry a trend for longer and take it to greater heights than is financially logical. In this context, probably the biggest story in recent years was the dotcom boom of the late 1990s.
The tech industry had a good story to tell and people bought into the story – that the internet was going to take over the world within a few years and bricks and mortar businesses were finished. You can see the impact of this “story” in the first half of graph I’ve pulled from Yahoo Finance comparing the NASDAQ with the S&P 500 at the time.
Performance NASDAQ v S&P 500 November 1998 – June 2001
What about the “Story”?
Buying into the dotcom/NASDAQ story and trend in 1998, or even 1999, and getting out when the trend broke, made a lot more money than buying the S&P 500 – whose “story” was weaker.
Of course, after the NASDAQ uptrend had broken, the big “story” was that the dotcoms were nearly all losing money – and even the ones making money had p/e ratios in the hundreds. The uptrend was over. The story was negative. The dotcoms’ fundamentals were appalling – it was time to sell short and double the profit you’d made on the way up.
When you’re trading, the “story” can be more important than the fundamentals.