When Livermore’s Game Stopped
His stock market speculations made him one of the richest men in the world. In today's monetary value, his fortune would be worth over $1.5 billion. Eleven years later, he shot himself and wrote in his suicide note:
<< I am a failure. >>
Jesse Lauriston Livermore was one of the most extraordinary speculators the world has ever seen. In the great crash of 1929, his massive short positions made him super rich. However, just five years later he had to declare bankruptcy. He should have better internalized the words that are on every Bank Gutmann business card:
<<Money. And how to keep it.>>
There is a lot of talk about short positions these days. Private investors hardly are exposed to it and that's a good thing. A short position speculates on falling prices on the stock market. If a share is shorted (sold short), it must first be borrowed in order to sell it on the stock exchange. If everything goes as planned and the value of the share falls, you buy it back later at a lower price and have profited. If, on the other hand, the share price rises, you have to cover the short at a higher price and have suffered a loss.
Pragmatically, short-selling is just as legitimate as buying a stock (a long position). Going long, you buy first and sell later. With short selling, it is simply the other way around; you sell first and then buy the share back at some point.
In a crash, short sellers can become the last standing buyer. When all the long holders sell in panic, the short-seller covers up their position, stabilizing the market. Short-selling has been around since stock exchanges have existed. As early as the 19th century, Daniel Drew said:
<< He who sells what isn't his'n, must buy it back or go to pris'n. >>
Speculation today
This nearly 200-year-old realization apparently inspired the members of an internet forum called wallstreetbets on the reddit platform. Wallstreetbets was on one side of the boxing ring and on the other side a hedge fund called Melvin Capital. The fight between the two occupied the media for a few days and achieved widespread attention - at least in the short term.
The hedge fund Melvin Capital had a short position in a stock called GameStop and retail investors on reddit started buying that stock, causing the price to rise. Every short seller has to post collateral (the "margin") and increase it when the price rises or just cover the short to limit further painful losses. The battle between the big hedge fund money and the small investor hordes has many different facets, which would go beyond the scope of this newsletter.
A customer question asked several times last week was: “What do these developments mean for the future of investing and how will we change our strategy?” My short answer: The whole story is as old as the stock market itself. This episode, too, will pass. No change is necessary.
Speculation at the time
Back to Jesse Livermore. In 1923, the book "Reminiscences of a Stock Operator" by Edwin Lefèvre was published, written in the first person and inspired by Livermore. Early in the book, the young Livermore is approached in a broker's office:
This is philosophically not so far away from an internet forum where someone calls on others to buy a certain stock together with him or her. Jesse Livermore was notorious for creating long or short pools and manipulating a particular stock up or down. He did this so successfully that it took the Securities Exchange Act of 1934 to stop him (1). This act also created the U.S. Securities and Exchange Commission (SEC). Livermore's life was never the same after that, because his market manipulations were explicitly illegal.
The very rule that hit Livermore right in the middle of his manipulative heart is still valid today and quite applicable to wallstreetbets members. However, I dare to doubt whether it is enforceable. In my opinion, it is also not necessary. Internet forums, in which individual shares were and are praised or condemned, have existed for a long time. They normally only have an effect on small-cap "penny stocks" (and are prosecuted by the Securities and Exchange Commission). We are not active in that area.
The forums always fail in the end due to lack of trust. Already in the Livermore book, it was said:
Even then, the sworn comrades-in-arms lost confidence in their own clique at some point and self-interest dominated behavior. Thus, the speculative bubble burst as quickly as it was created.
The importance of trust
Trust is a very important issue for us. It is often given to us by customers across generations. This trust also guides our actions on the markets. That is why we pay attention to quality at all points in the investment process. All in the interests of our customers: Money. And how to keep it.
(1) Section 9(a)2 of the Securities Exchange Act of 1934:
To effect, alone or with one or more other persons, a series of transactions in any security registered on a national securities exchange creating actual or apparent active trading in such security or raising or depressing the price of such security, for the purpose of inducing the purchase or sale of such security by others.
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